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What is fundamental analysis?

Fundamental analysis is the study of global economic news and indicators affect financial markets. It covers everything from a company's profits for the year to interest rates. It can range from social change such as a growing middle class in China to essential monetary policy.

The most important thing to remember with fundamental analysis that it all the factors dealt with - interest rates for Forex, consumer demand for commodities and profits for stocks – are almost always already factored into the price when you trade.

Commodity trading

For commodity trading, examples of economic indicators used in fundamental analysis can range from new car production figures (demand) to platinum output in South Africa (supply).

Because the range of commodities and their uses is so large, the list of examples is endless. However, there are a few important commodity price indicators depending on the material.

Oil

With oil, there are two crucial indicators used in fundamental analysis – OPEC production and the state of the overall world economy.

First, let's deal with OPEC, which sets agrees how much oil is to be produced by some of the world's leading oil exporters. If oil prices are low, for example, OPEC may decide to limit exports in order to bump up the price.

With the second indicator – the overall world economy – it's simply a matter of GDP growth in countries tends to correlate with rising oil prices. However, as with all fundamental analysis, it's a case of what people (traders and investors) believe will happen to the world economy. As we've said before, the price of oil that you see will already have factored in the current state of the world economy.

A Chatham House report into oil prices puts it simply: "Oil prices increasingly respond to expectations, and particularly to expectations about economic growth, rather than to short term fundamentals." The think tank points out that short term supply and demand are "extremely inelastic" and that price changes cause "little or no volume response". However the same report does argue that oil prices are "increasingly correlated" with GDP growth.

Gold

Gold prices tend to rise in slumps and periods of economic instability, and fall when the good times are rolling. When people are afraid to invest in equities like stocks and shares, they will put their money in the 'safe haven' that is gold. But remember, this correlates only with the macroeconomic trends of the day. As with all these things, it's always a matter of perception.

The same Chatham House report on oil covered gold prices and other economic indicators. Essentially, there was little to link gold prices with anything – the only conclusion is that gold prices have been rising significantly.
Platinum Group Metals

Platinum group metals, of which platinum, palladium, ruthenium, rhodium and iridium are the main ones used in industry, are an interesting case. Production is limited to southern Africa, with South Africa accounting for 80% of production and Zimbabwe around ten per cent. The rest is in Russia and Canada.

In 2012, there were direct correlations between the price of platinum, the main metal in the group, and supply problems in South Africa caused by labour unrest. In terms of fundamental analysis, you could also look at demand – platinum and palladium are both used extensively in the jewellery and the automotive industries. But the demand side appears less important than the supply side.

This article is also available with a focus on Forex trading and Stocks and Indices trading.

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