Volatility can be described as the price variance of an asset over time. The wider the price range on a daily, weekly, monthly, or longer-term basis, the higher the volatility. It is often the variance of a market that makes it attractive or unattractive to market participants that have different risk profiles.
Active traders typically thrive on volatility because when prices are highly volatile, it attracts more speculative and short-term trading activity. Traders try to take advantage in the immediate or near term while investors tend to look for more stability through either capital appreciation or yield.
Commodity volatility tends to be the highest of all the different asset classes. Whether oil, natural gas, soybeans, corn, gold or a few other commodities, this tends to hold true. Here are a few of the reasons and why the current volatility is not likely to ebb any time soon:
Geopolitical and Headline Risk
Commodities are sensitive to changes in the global macroeconomic landscape. Commodity reserves are located all over the world and the world has never been more economically connected than we are today. Political events in one region can immediately affect prices everywhere. Wars or violence in an area can close significant logistical transportation or export/import routes. Most notable today is the tariff and trade war situation which is not going away anytime soon.
Supply in the Earth's Crust
The concept of supply and demand is the most basic of all economic fundamentals and is the backbone of market economy. Commodities come from areas of the world where reserves are present in the crust of the earth and where extraction, production and refinement occurs for a cost less than market value. Since almost every person in the world is a consumer and "demands" these commodities, there is rarely a balance. This inherently leads to pricing volatility.
Hurricanes, Drought and Cold
Extreme weather conditions have a direct impact on commodity pricing. A recent cold streak sent natural gas futures spiking to their highest level since the 2014 polar vortex. Hurricanes along the Gulf Coast have caused refinery shutdowns. A few years ago, a severe drought in the United States caused prices of corn and soybeans to skyrocket. Commodity markets are closely connected to weather and natural disasters, which can increase volatility.
Looking to 2019
Tariff and trade talks and continuing negotiations with North Korea are certain to extend well into 2019. Global supply of oil has recently far outweighed demand causing oil prices to fall approximately 30 percent in just a matter of weeks. And the effects of climate change seem to be creating more natural disasters and extreme weather patterns. Even if these conditions are resolved, new issues will arise. With so many powerful forces driving commodity markets, investors and traders don't often have to wait long for volatility to surface.
Written by Scott Bauer. Read more from the author here.
(This article is sponsored and produced by CME Group, which is solely responsible for its content.)