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Supply

According to standard texts on supply and demand, supply represents how much the market can or wants to offer. The quantity of supply is the number of products that the supply side is willing to sell at a certain price. But when we are talking about the supply side of an asset, we are actually talking about the relative scarcity of supply. We look at whether the asset is hard to get and whether there are costs associated with producing it. There are two very important factors that can influence the supply of an asset.

The first is what we call the cost of production. By some, this is considered to be the most significant way to value a commodity. This is because floors for commodities are often established when the marginal players have all been removed from the market and only the suppliers who have the lowest cost of production remain. When it comes to commodities, if there is not enough demand for a physical commodity, a lot of producers will simply stockpile the raw materials and not bother producing the asset because prices are simply too low. Thus, it is important for us to know what the cost of production of a commodity is. If there is simply less demand for a physical asset, prices will explore towards where the supply chain really is. Sometimes that low can be pretty low. For those that are into bitcoin, this can also be something worthwhile to keep in mind. At certain times, mining bitcoins can be very profitable for a lot of people, even those that pay high energy prices. However, at times that demand drops, the miners that pay high energy prices will have to shut down their computers, leaving only the miners with the lowest cost of production to continue mining.

A second factor that often can drive the fundamentals of a commodity are supply shocks. A supply shock is an (unexpected) event that changes the supply of a product or commodity which often results in (sudden and dramatic) price changes. One example of a supply shock would be a weather event such as a drought. A drought can dramatically decrease the production of certain agricultural commodities, resulting in a large increase in the price of that commodity.

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