Fundamental analysis is a means of analyzing commodities and trying to predict where the prices of commodities should be trading and what they will do in the future. The main basis for fundamental analysis is supply and demand.
Supply and demand is a very simple equation, but it gets more complicated when you try to forecast prices in the future. Commodities trade in cycles. Sometimes supplies will be tight and prices will be high. Other times, we just have too much of a commodity and prices fall accordingly.
Price movements in commodities using fundamental analysis can be broken down into these simple formulas:
The supply of a commodity is the amount that is carried over from previous year(s) of production and the amount that is being produced during the current year. For example, the current supplies of soybeans would include the amount of crops in the ground and the amount that is left over from the previous season. Typically, the more that is carried over from the previous season, the lower the prices will fall.
There are many factors that can impact the supply of commodities like weather, amount of acres planted, production strikes, crop diseases and technology. The main thing to remember when using fundamental analysis is that high prices for commodities will lead to an increase in production, as it is more profitable to produce commodities when prices are higher. As you might expect, demand will typically drop as prices move higher.
Demand for commodities is the amount that is consumed at a given price level. The rule of thumb is that demand will increase when the price of a commodity moves lower. Oppositely, demand will decrease as the price of a commodity increases. There is an old saying among commodity traders that low prices cure low prices. This means that more of a commodity will be consumed at lower prices, which lowers the supply and thus prices will eventually increase.
Fundamental analysis of commodities is simple economics. Consumption patterns change as the prices of commodities move higher and lower. Most professional commodity traders like to know what the big picture is with commodities using fundamental analysis and then they use technical analysis to time their entries and exits.