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Fundamental Analysis - Commodity Market Conditions

Commodity Futures Fundamental Analysis

Fundamental analysis involves research

What is fundamental analysis?

There are two basic approaches to market analysis -- technical analysis (of market data) and fundamental analysis (of market environment). For academics, fundamental analysis is the study of supply and demand forces in the economy. For traders, it is a method to forecast price movements of individual commodities and/or entire markets by looking at economic indicators and government policy, within a business cycle framework. Because there are hundreds of supply and demand forces in effect at any particular time, the fundamental analyst builds economic models to reduce the number of these variables to a few dominant forces. The efficacy of these models is limited only by the analyst's ability to identify dominant factors.

Learn About Fundamental Analysis

As a trader, you will come across many factors that you must consider before entering or exiting the markets. Some of the most important aspects to look for are economic events that can move the markets drastically one way or another.

There are many types of economic events including releases by a governing body, changes in sales or consumption of commodities, and increases in supply and demand. All of these can affect the markets you trade, making it important for you to know how and when these changes are happening.

  • What is Gross Domestic Product (GDP)?
  • About the Retail Sales Report
  • What is the Non-Farm Payroll Report?
  • Understanding Consumer Price Index and Producer Price Index
  • Understanding U.S. Housing Data
  • What is the European Central Bank?
  • Understanding the FOMC Report
  • Understanding the Oil Data Report
  • The Importance of Consumer Confidence Surveys

Does fundamental analysis explain or forecast market behavior?

It can do both, depending on the economic variables used. In an explanatory model, the variables used are measured at the same time as the price they seek to explain. In a forecasting model, either past values are used to extrapolate future values (the explanatory variable must really be predictive), or, a knowledge of forces outside a particular commodity is used to forecast future prices (the explanatory variable must have high correlation). To use fundamental forecasting for trading, one does not trade until the sufficient precursor conditions materialize.

Forecasts are as strong as the data used to make them. Much fundamental data, no matter how accurate the estimates, is based on samples. In addition, the estimates are usually subject to constant revision. Thus, a forecast based on price data, such as in technical analysis, promises to have greater accuracy.

Through model building, one may have a thorough understanding of a market's structure, but still have no information that will lead to the profitable establishment of market positions. A myth surrounding fundamental analysis in futures is that explaining price changes is equivalent to forecasting price changes.

While the building blocks of all fundamental analysis includes indicators for supply, demand and government economic policy, forecasting models usually include at least one type of economic indicator in relation price data.

Fundamental analysis involves research into the underlying factors that determine the price level for a financial asset or a commodity. The type of analysis you would want to perform will depend heavily on which futures market you choose to invest in. For instance, if you decide to trade futures on Treasury Bonds, you would want to analyze the fundamental factors that drive bond prices. These include the level and direction of economic activity, Federal Reserve monetary policy, supply and demand, investor sentiment, and daily economic and news releases. On the other hand, traders of futures contracts on corn would be far more interested in analyzing weather reports, details on acreage planted and crop yields, supplies of alternative grains and shipping costs.

Regardless of the market you choose, before beginning trading you should do a great deal of additional research into the underlying fundamentals and market conditions of that market in order to maximize your opportunities for success.