Fundamentals and Commodity Prices

Commodity markets occasionally co-move with the broader macro markets for reasons beyond their own fundamentally driven physical characteristics. This chapter focuses on two related avenues to look beyond the fundamentals of counting barrels, tonnes, bushels, or molecules. The first section uses a principal component analysis to disentangle how fundamentals versus non-fundamentals drive commodity prices and focuses on the crude oil market. The results are intuitive and allow isolating the extent to which supply and demand matter to price changes experienced in the market. Furthermore, the results enable understanding whether the diversification benefits of commodity markets exist in almost real time. Second, given the ability to segment fundamentally driven commodities from others, the chapter focuses on how much supply or demand factors attribute to the fundamental variation in prices. The analysis reveals that, in the oil market, supply concerns drive prices during geopolitical tensions, while demand concerns dominate during economic crises.