Taking Out Supply Vs Moving Demand: What Ignites Prices?

What influences price more potently, higher demand or the lack of supply? The answer could vary from case to case but for undifferentiated commodities it seems that the latter, which is lack of supply, influences price more decisively than a demand surge. 

So you have this brilliant example of the most abundantly available commodity on the earth, Bauxite, but prices could still be influenced by the lack of its supply, or the perception that is embodied in the market’s understanding that supply gap exists buoy prices, whereas the demand could be indifferent. 

Or take Oil for example, even a perceived disruption, could be just a Tweet and the prices get impacted immediately, although you have such a huge built up of inventory lying around from Cushing to anywhere else. Taking out supply is the easiest and the surest way to raise prices. The photograph above of the Cushing Oil fields tells this story brilliantly.

The strengthening of demand on the other hand takes time to act to make an impression on the price. 

Why would demand pick-up take so much time to build-up whereas the hint of a supply shortage impacts prices so much more, deterministically? Are our statistical models biased towards supply shocks than demand surge? 

Are we mentally hard wired into believing that supply has a stronger influence on prices than demand? But actually this is simple to understand when we take some examples. 

For any demand-supply curve, for the supply curve to shift to the left takes far less effort than the shifting of the demand curve to the right. Stopping supply is a switch but increasing demand is another matter. 

The other reason is more to do with the current state of the global economy where we have inherent surplus in production capacity globally, therefore any demand surplus is simply taken away instantly by the adjustment in the slack existing in the supply side without any change in the prices. 

For a highly differentiated product, this does not work at all, the queue you will notice in front of stores when a product is launched is not because there is a fear that supply is short, but because you just want to be the first buyer. Here the delta change in demand could disproportionately create a surge impact on prices. 

So next time when you see the queue outside a Jimmy Choo store where some new launches are happening, you will remember this that the surge in demand can be strongly correlated with prices, in fact more the prices more the queue lengthens.

The same direct correlation is true for Equity markets where a substantial amount of stock moving out of the market (due to buy-backs) immediately impacts the prices positively. No wonder buy-backs are the best way to a positive price signal.