If there is higher demand than supply, the prices go up. When prices go up, consumers buy less and producers produce more, bringing the price to some equilibrium.
If there is higher supply than demand the prices go down, consumers start buying more, producers produce less and the price comes back to equilibrium.
Here is a graph of the Commodity index ETF for the past 5 years. As we have become more efficient producing commodities, supply has increased and the prices have gone down. If you were a believer of commodities as an investment, you lost 50% of your money during the past 5 years. Show that to the person who recommended commodities for your portfolio.
Governments stop subsidizing commodities
While I am on the subject, I want to express that I dislike it when governments get involved in commodity markets. It costs millions of dollars to taxpayers and to consumers. Governments all over the world subsidize all kind of agricultural products. This subsidy comes out of tax payers pockets. This is the subject for another blog post.
This article was republished with permission from Alain Guillot.