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What is the Relationship between Commodity Prices & Interest Rates?

When investors who are invested in the commodity market think about the future direction of commodity prices, they tend to focus on short-term supply or long-term trends in China, India, and another fast-growing developing world. But, what they never look upon is the influence of interest rates on commodity prices. If one of the few important things history has ever taught us is that ‘there is a strong relationship between commodity prices and interest rates’.

The commodities like crude oil, metal, minerals, and agricultural products have a strong correlation with interest rates. There is a long historic inverse relationship between commodity prices and interest rates. It is because of the cost of holding inventory. When the interest rates move higher, the commodity prices tend to move lower and when the interest rates move lower, the commodity prices tend to move higher.

Therefore, it is always recommending keeping interested rates in mind while assessing the future price of commodities. But, even that’s not always true! You can’t just rely on a single relationship when it comes to commodity trading.

As per Jeff Frankel, you also need to consider the important concept of “nominal” interest rates and “real interest rates”.

  • Nominal Interest Rate: It is the rate of interest that taken into account before inflation.
  • Real Interest Rate: It is the rate of interest calculated by the difference of nominal interest rate and forecasted inflation.

When we talk about the relationship between interest rates and commodity prices, it is the real interest rate that we’re concerned with. It is important because when you see interest rate rising, you will have to ask yourself, “Is that increase interest rates sign of inflation or not?”

The real interest rate we’re talking about impact commodity prices in three different ways. As you know that most of the commodities are storable and owner of the commodity have to make a decision. When he/she does that there are certainly other things to consider such as price expectations, storage costs, and risks.

The higher the interest rate, more likely you will extract the commodity which by the way is a non-interest earning and liquidate it as soon as possible in order to earn interest through the sale.

The second reason behind the impact of real interest rate on commodity prices is the carrying cost of inventories. Everybody is concerned about the cost of holding inventories. When the real interest rate rises, you will try to lower your inventories which automatically lower demand.

And the third reason is the financial speculation in commodity markets. Besides, commodities have become part of the portfolio of many investors for hedging. When the real interest rates are low, these investors often look for other assets to invest in such as stocks and bonds.

Final Thoughts: -

Interest rates impact commodity prices in a big way. Unfortunately, we forecast the future direction of commodity prices based on supply, inventory, and nature. However, there are many macroeconomic factors that affect commodity prices hugely. Interest rate is also one of the major economic factors including gross domestic product (GDP) and inflation.

Hope, this article helped you in understanding the relationship between commodity prices and interest rates. Nevertheless, if you have any query or would like to suggest something here then please don’t forget to mention in the comment section below.             

This article was written by Wasim Raza for on .

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