The financial markets -- including the stock, bond, currencies and commodities markets -- are inseparably linked in a number of ways, causing trends and events in one market to affect price movement in other markets. For example, because commodities are drilled, dug, produced and refined by companies listed on stock exchanges, investors' decisions in the stock market can affect the prices and availability of commodities throughout the economy. Understanding these effects, as well as the effects that commodities can have on the stock market, can help you make more informed decisions trading stocks or commodities.
Stocks and Commodities Basics
Stocks represent individual shares of ownership in corporate businesses. Stocks can be purchased directly from investment banks in initial or secondary public offerings, or they can be bought from and sold to other stock investors on stock exchanges around the world. Commodities consist of the basic materials and natural resources used in virtually all production and manufacturing processes. They include oil, natural gas, coal, gold, copper, iron, certain fruits and basic foods, such as wheat and barley. Both stocks and commodities are bought and sold on physical trading floors and through electronic trading networks without physical goods ever being exchanged.
Financing Public Companies
The stock market provides financing opportunities for oil drillers, coal mines, natural gas drillers, rock quarries and any company focused on securing and selling commodities. Through initial and secondary public offerings, smaller commodities companies can take their operations to global levels. This has the effect of increasing the supply of commodities in the market, as more businesses are engaged in procuring or producing them. An increased supply of commodities can reduce prices without a corresponding increase in demand. If increased supply leads to increased price competition, it can affect the income statements and balance sheets of publicly traded commodities companies, which in turn can affect their company valuations and ultimately the value of their stock in the stock market.
Strength of the Commodities Sector
The strength of companies in the commodities sector of the stock market can create self-fulfilling expectations brought about by investor sentiment. If the cost of drilling for oil rises significantly, for example, stock investors may expect oil drilling companies to report smaller-than-expected earnings or profit in the next quarter. This can influence investors' decisions so that the drillers' stock prices drop in anticipation of the next release. With this lowered expectation already built into the stock price when earnings are released, the exact figures in the earnings reports can cause rapid upward price movement if they vary significantly from investors' expectations.
Commodities Effect on the Stock Market
The commodities market affects the stock market more significantly than stocks affect commodities. Changes in commodities prices create a trickle-down effect that ultimately influences prices in the stock market. Since commodities represent the basic building blocks of all products in an economy, the prices of commodities affect the operational costs of corporations. This can force corporations to change the prices they charge consumers, and this ultimately leads to a different financial picture being presented in quarterly and annual reports. The annual reports then prompt stock market investors to make different decisions that affect the prices of individual stocks and larger trends in entire industries and stock market segments.
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