3 Reasons the Price of a Commodity May Fall

There are a number of different reasons that the price of a commodity could fall rapidly. Here are a few reasons that the price of a commodity could go down.

1. Obsolescence

One of the biggest fears of a commodity investor is that their commodity will become obsolete. When this happens, the value of their investment will plummet quickly. It may be reduced to nothing faster than they can sell their interests in the commodity. For example, let's say that you invested heavily in oil. While oil has always been a popular commodity to invest in, we all know that it is a limited natural resource. Therefore, at some point the oil wells will dry up. When this happens, anyone that has a futures contract on oil is going to be in trouble. They are holding a contract on a commodity that no longer exists.

This could also happen if something else is discovered that makes oil irrelevant. For example, let's say that someone discovered another source of fuel that was readily available, more efficient than oil, and cost less than half as much. If this were to happen, the value of oil would plummet because everyone would start turning towards the new energy source.

2. Overabundance

Another reason that the price of a commodity could fall drastically is because of overabundance of that commodity. When the supply of a commodity is too great, the price will respond accordingly. For example, let's say that more and more farmers started to turn their farmland into wheat fields. Instead of growing corn or another type of crop, they just all decided to grow wheat. If this happened, our society would have an overabundance of wheat. Therefore, at some point the price would have to go down to accommodate for this overabundance.

3. Decreased Demand

The price of a commodity can also rapidly fall because of a decrease in the demand for this product. For example, this happened with oil at one point. When the price of a gallon of gasoline got up to around $4 per gallon in the United States, many people decided to cut back on their fuel consumption. Many of them decided to ride bikes or walk instead of using their cars. People carpooled and did whatever they had to do in order to save money on purchasing gas. As a result of this, the price for gasoline went down substantially. At one point it was nearing $1 per gallon again. Therefore, anyone that had purchased oil contracts before this decrease in demand took place lost a substantial amount of money. While ultimately the demand for oil will still go up steadily, in the short term, this decrease in demand drastically affected the overall price of the commodity itself. As a commodity investor, you always want to be aware of the demand situation for your commodity.

blog comments powered by Disqus
Scottrade