How Commodity Prices Affect Other Sectors ?
The movement in commodity markets does affect the price trends in other markets such as bonds and equities. However, commodity markets themselves are largely immune to the effects in these other markets. This does not mean that they are not affected by these movements at all. This just means that the degree of this effect is much smaller.
Also, the reason behind this is fairly obvious as well. Commodities are largely used for consumption purposes. Also, they are necessities. Therefore, if their prices rise, a larger portion of the budget is spent on them leaving little room for other expenditure.
In this article, we will concentrate on how price movements in essential commodities like energy, food and metals create movements in other sectors.
Real Estate
Real estate is a huge sector in any nation. It is also amongst the largest employers. Therefore, a slowdown in real estate is bound to have ripple effects. However, real estate uses a lot of commodities as inputs. Even if we exclude the basic raw material i.e. land, there are still other commodities like iron and steel, wood and other metals that are extensively used in this sector. Therefore, if the prices of commodities rise, an immediate effect is seen in the prices of real estate. This causes the sales to fall causing a decline in bank credit creation! Also, the wages paid to workers decline during this period further accentuating the cycle.
A fall in the real estate market will also affect these commodities since there will be less demand. However, the intensity of this effect will not nearly be as much.
Auto Sales
Just like real estate, the automotive sector is also the backbone of any local economy. It is a heavy manufacturing industry and employs a large number of people. Also, just like real estate, the automotive sector also uses a large amount of commodities as inputs. The basic raw material used is metal! Therefore, if mining companies hit a lean patch and are unable to mine enough metal, the prices will rise. The auto industry will have no alternative but to pass on this price rise to the consumer.
Telecom
The prices of commodities like petrol and diesel have a direct effect on the telecom sector. This is particularly true in countries like India wherein electricity is not available in abundance. Most of the telecom towers in rural areas are powered by generators. These generators use petrol or diesel as their fuel. Without using this fuel, the telecom sector would not be able to function. These rural towers provide the required level of connectivity which allows telecom companies to assure customers regarding continued coverage.
Hence, if the price of petrol and diesel rises, so does the cost of maintaining a telecom network. This cost inevitably gets passed on to the consumer and also affects the value of these stocks in the equities market.
Retail
The price of oil also has a significant impact on the performance of the retail sector. This may seem odd. However, this is true. Consider the fact that most products present in the retail store are either made from plastic or are packaged in plastic. Plastic is a by-product of oil manufacturing. Hence, if the prices of oil rise, so does the price of plastic. This has an impact on the retail business and they are left with two alternatives. One is to pass on the hike to the consumer which is difficult given the competitive nature of the retail market. The second alternative is that the retailers absorb the price hike themselves. This will end up hurting their margins and will eventually show up on the stock market.
Gold
The world considers gold as a counter cyclical asset. This means that when the going is good, investors prefer equity markets over gold. Therefore, as markets crash, gold becomes the asset of choice. Investors invariably flock to this yellow metal to hoard their life savings to prevent it from declining in value.
Food Processing
A large number of commodities listed on the market are related to food. These commodities are used extensively by FMCG companies and other food processing organization. Therefore if the price of tomatoes rises, so will the price of tomato sauce! Companies like Heinz which manufacture food products are adversely affected by these price hikes. Also, restaurants like McDonalds and Pizza Hut are adversely affected and so are companies like Starbucks. These are the names of global behemoths and their profit margins have an impact on stock markets across the globe.
Spill Over Effects
Our economy is integrated. As we have seen that a cause in the commodities market has effects in several consumer markets and also finds its way to the stock markets. It is important to know that the cycle does not stop here. Instead, sectors like banking also tend to get affected and the result in a repetition of the entire cycle. A fall in commodity prices causes a decline in the overall economy! It is for this reason that commodities are often considered to be a leading indicator of the state of economic affairs and provide definitive clues to other markets.
source:www.managementstudyguide.com