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Why are the prices of some commodities (e.g. oil) more volatile than others?

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partially due to speculators creating "artificial" demand. –  Matt Phillips Jun 27 '11 at 0:28
    
Oil is primarily due to speculation, and not due to shortage of supply as everybody assumes. Banks were pointing at the price reaching $200/b, because of their in house bets on price speculation. –  DumbCoder Jun 27 '11 at 7:42

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Prices and volatility for a commodity are driven by changes in supply and demand, more often the latter, since supplies are usually "fixed" in the short term.

Oil is a particularly volatile commodity because it is genuinely critical to so many things, transportation, manufacturing, electric power, etc. Because of this fact, it has numerous parties ("agents," in economic language) monitoring available supplies. This includes whole governments, that sometimes build up strategic petroleum reserves.

Because of the involvement of so many parties (actual and potential), trading in oil is a "crowded" trade, which produces volatility. Imagine the back and forths of a bunch of people at a party in a crowded room.

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This answer happens to be demonstrably wrong, it is a shame it is marked with a check here. Fresh water is genuinely critical to so many things, and demand happens to fluctuate quite a bit, but price remains relatively constant because supply is plentiful. There's no shortage of parties monitoring supply of fresh water, too. Crowded trades, by the way, have to do with valuation, not volatility. –  Tal Fishman Aug 25 '11 at 19:53
    
sheegan: The comment was that prices are driven by CHANGES in supply and demand (and the implication was, over a critical region). Water is, for now, OUTSIDE of a "critical" region (being plentiful). But if demand continues to rise faster than supply, it MAY enter a critical region and have its price be market driven. –  Tom Au Aug 25 '11 at 20:00
    
Demand always equals supply, so changes in demand also equal changes in supply. A shift in demand causes price to adjust in order for supply to meet demand. The difference between water and oil is that the next X gallons/barrels cost a lot more (relative to current prices) for oil. As for whether a commodity is in what you label a "critical" region, that seems subjective and ill-defined at best. –  Tal Fishman Aug 25 '11 at 20:15
    
Projected supply affects more than actual supply. An expected shortage that does not manifest causes a greater increase than an actual unexpected one. Demand has very little impact as has been seen in recent gas prices. Low demand did not reduce the price of the gas. But expected shortages that never materialized have cost us over a 50cents a gallon for over a year now. –  user4127 Aug 25 '11 at 21:03

Any number of reasons.

Technically, large positions being bought/sold in the market can trigger others to follow.

Fundamentally, disruptions in supply can trigger uncertainty or volatility in the markets, especially with oil. A good chunk of the world's oil is in places that doesn't have the best track record for peace and prosperity, shall we say? But even under the best of times, a hurricane can take out refining capacity and the price can spike up.

As for other commodities, there are other things can can disrupt supply: crop failure, flooding, mines collapsing, the works.

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Prices are driven by the demand for a commodity and the availability of that commodity. For some commodities, projecting demand is easy or irrelevant.

Take gravel as an example... if I order 50 tons of gravel, I find a supplier who send me whatever is in his warehouse and if this is insufficient, he digs it out of a quarry and puts it on a truck. No big deal -- the cost of generating more supply is low. (as is the cost of holding excess inventory... rocks don't go bad!)

Lettuce is a little more complicated. Based on past orders and growth trends, you can pretty easily gauge demand. The trick is, delivering the supply... all sort of things like weather, bugs, disease can disrupt my ability to send you sufficient lettuce. The cost of getting additional supply is moderate -- I just truck in lettuce from California.

Gasoline is tougher because demand shifts based on season and price elasticity. And the supply chain is very long... I live in NY, so most of my gas comes via a drill rig in Saudi Arabia or the Gulf to a refinery in New Jersey to a tank farm along the Hudson River to my local gas station. At any point in that chain, a critical path issue can result in a supply constraint or overage, and those problems have cascading effects on price.

So to answer your question, the price is volitile because there is alot of demand, a complex supply chain as well as a number of independent variables (currency exchange rates, weather, etc) that can affect the price.

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Could speculation make an item more volatile?
Speculation actually reduces volatility. Speculators purchase an item believing that the price of the item will go up in the future. The speculator is predicting either increased demand or decreased supply. When the price does go up the speculator sells the item. By selling the item at the higher price the speculator increases the supply of the item into the market and the price of the item will not rise as fast due to the additional supply of the item supplied by the speculator. In this way speculators reduce volatility.

Why is oil more volatile?

First, the unit of measure must be taken into account. Oil priced in US dollars is much more volatile than oil priced in gold. This is due to the rapidly changing value and demand for the US dollar (USD). The chart below shows the volatility of oil priced in US dollars versus the volatility of oil priced in gold. The standard deviation of the price in USDs is around 29 while the deviation when priced in gold is 0.015. enter image description here

Secondly, some of the major oil producing countries have stopped, or attempted to stop, accepting US dollars for oil. Iraq in 2000, and Iran in 2009. This increases volatility (in USDs) since buyers must quickly dump some of their USDs in an attempt to obtain some euros to purchase oil from these major producers.

Thirdly, destroying the infrastructure used for oil production can cause significant disruptions in the supply of oil which will increase volatility.

enter image description here enter image description here

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LOL A picture is worth a thousand words? –  George Marian Jun 29 '11 at 7:51

The volatility of a commodity typically depends on how volatile is demand and how flexible is supply. In the case of oil, it is more volatile than in the past because most of the spare capacity from OPEC has been taken out of the system. Commodities whose demand responds similarly to economic shocks but with much greater excess supply, such as natural gas in the United States, are considerably less volatile, although a few years ago when supplies of nat gas were tight in the US, volatility of nat gas was greater than volatility of oil.

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