Resource prices & currency fluctuations move stocks

The price of natural resources such as crude oil, lumber, cotton or gold can have a dramatic effect on a company's profit and its share price, depending on how much it produces or consumes such commodities.

Similarly, foreign exchange rates can affect how much a company pays for the goods it imports or consumes and earns for the goods it exports or produces. This too will affect its profit.

Commodity and currency markets are very volatile – even more so than stock markets – and price changes can be very fast.

Shares traders should therefore keep a constant eye on both markets.

Commodities

Companies that actually produce a commodity, such as miners or OIL companies, have perhaps the most direct exposure to commodity prices.

If the price of a company's product increases, it will probably earn more profit, which should help increase the value of its shares. A big increase in the price of crude OIL, for example, will tend to push up the shares of OIL companies dramatically.

A company that uses a lot of OIL to produce its goods will probably earn less profit if the price of crude rises and its costs increase. Shares in plastic producers, for example, tend to suffer if OIL prices rise.

Further down the chain, companies that use a lot of plastic to produce their goods – for example food producers that shrink-wrap their products in plastic – will also see their profit margins shrink if the price of OIL, and therefore plastic, rises. This could push down their share price.

Companies can choose to pass on their higher costs to their customers in the form of higher prices. This may then reduce demand for their products and hurt their earnings or share price that way.

Index weighting

For investors who track or trade stock market indices, it is also important to note that big mining and natural resource companies account for a very large chunk of the total value of indices such as the FTSE 100.

Any change in commodity prices will therefore tend to produce big changes in the overall level of stock markets, and this can affect traders' risk appetite for shares in general, regardless of whether the companies involved produce commodities.

Thinking laterally

Shares traders need to think laterally when they monitor commodity prices as the relationship between some natural resources and the companies' shares they are trading may not always be obvious.

Here is a list of some key commodities and the kind of companies they could affect:

• OIL: Crude OIL and related OIL products like diesel and petrol are a big cost for a huge variety of industries. This is because petrochemicals are used to produce so many products – from tyres to asphalt and most kinds of plastics. All companies use energy or fuel, if only to heat their premises, while some – for example transport companies – consume a great deal.
• GOLD: GOLD is used to produce jewellery but also has industrial uses, for example in the production of medical products and glass. It also has a unique role in the economy as a virtual currency, and as an asset that investors think is safe when economies are weak. This makes its price quite volatile.
• Lumber: This is a big cost for construction companies, but also for any kind of firm that is in expansion mode and wants to build new stores, factories or restaurants.
• Cotton: Apparel makers use a lot of cotton, as do producers of furniture, household linen and even items like coffee filters. This cost is also passed on to retailers.
• Wheat: Wheat is used to produce everyday items like breakfast cereal and bread. Food producers, supermarkets and grocers are therefore heavily exposed to its price.
• Corn: Corn is used far more widely than many consumers imagine – for example in the production of tyres, building materials and biofuels like ethanol. Manufacturers and retailers of such products are therefore exposed to its price.
• Coffee: Coffee producers and coffee-shop chains are obviously exposed to coffee prices, but so too are most kinds of restaurants as well as supermarkets and grocers that sell it.

Currencies

Virtually all companies are exposed to foreign exchange markets, and this will affect their profits and their share price.

If, for example, a UK-based company makes car parts and exports them to Europe, it will probably be paid for those parts in euros. Many of its costs however – for example wages for its workers, energy bills and the cost of renting or buying premises – will be payable in pound sterling. It will probably also import a lot of the metal or rubber it uses to make cars from overseas and may pay for these in US dollars.

If the price of US dollar rises against the pound, the company's earnings will probably fall and so could its share price. If the price of euros rise against pound sterling, its earnings will probably rise and so could its share price.

Indirect effect

Even companies that do not directly import or export goods will be affected by foreign exchange rates.

For example, a retailer in the UK may buy many of the products it sells from domestic wholesalers or manufacturers, rather than importing them itself.

Even if the entire product it is selling – for example, a mobile telephone – has not been produced overseas, it is likely that many of its parts will have been.

This could dent demand among UK consumers for that telephone, hurting the earnings and share price of the retailers that sell it.

Summary

In this lesson you have learned that ...

• ... the price of natural resources such as crude OIL, lumber, cotton or GOLD can have a dramatic effect on a company's profit and its share price, depending on how much it produces or consumes of such commodities.
• ... foreign exchange rates affect how much a company pays for the goods it imports or consumes and earns for the goods it exports or produces – they too will affect its profit and share price.
• ... commodity and currency markets are very volatile and price changes can be very fast, meaning shares traders should keep a constant eye on both markets.
• ... if the price of a commodity that a company produces rises, it will probably earn more profit, which should boost its share price.
• ... if the price of a commodity that a company consumes a lot of rises, it will probably earn less profit, which could push down its share price.
• ... shares traders need to think laterally when they monitor commodity prices as the relationship between some natural resources and the companies' shares they are trading may not always be obvious.
• ... companies that import and/or export a lot of goods will also be very exposed to foreign exchange markets.
• ... if a company pays for imports in US dollars but receives euros for goods it exports, its profit and share price could fall if the US dollar strengthens against the euro. The same company's profits and share price could rise if the US dollar weakens against the euro.
• ... a company that sells a product that is made from parts that are produced overseas could see its profit and share price fall if its home country's currency weakens against the currency of the country where the parts are produced.