Overview
A vast and highly dynamic market like foreign exchange is influenced by a gazillion fundamental factors like interest rates, politics, employment figures, and the list goes on.
As any studied analyst would tell you, traders need to often explore beyond their charts and into other instruments to make sense of what’s happening in forex presently.
Commodities, particularly gold and oil, just so happen to be one of the markets analysts observe.
Of course, it’s not just about knowing that certain commodities impact the forex markets but specifically which ones and how. Worry not, as this article will explore the influence of commodities in forex and the long-established commodity-currency correlations known.
Recognizing these linkages can undoubtedly aid in helping any trader make more educated decisions in the markets.
How commodities affect the movement of currencies
Any country’s currency is, by and large, a representation of its economy. A nation is quite similar to a business in that it relies on certain goods and services it produces, making the bulk of its profits.
In an economic sense, this would be locally-produced exports a country sells internationally to boost its economy. Of course, one of the most valuable exports for any state is commodities, particularly if these make up a considerable part of a nation’s gross domestic product (e.g., Canada and oil).
When a country exports a commodity, it will need to use its native currency in the transactions. If this nation trades a lot of the said commodity, it would naturally make its currency more valuable because of increasing demand.
Conversely, when production or interest for that product subsides, the nation’s currency would be less-utilized in transactions, making it less valuable relative to other currencies.
List of common commodity correlations to know
When referring to ‘major’ or USD-based currencies, there are primarily only three currencies heavily influenced by commodities in forex, namely the Canadian dollar with oil and the Australian/New Zealand dollar with gold.
The other market experiencing impact, albeit to a lesser extent, on commodities is the Japanese yen. If you trade exotic pairs, other so-called commodity currencies include the South African rand, Chilean peso, Brazilian real, and Norwegian krone, all of which you’d need to study beforehand.
However, for prominence purposes, we’ll detail the two most prevalent currency-commodity correlations to follow.
Canadian dollar and oil
According to 2020 research on Wikipedia, Canada is the fourth-largest crude oil exporter. However, the oil itself is the nation’s #1 export, meaning the nation’s economy is heavily reliant on it.
When oil prices increase, this means more CAD-denominated transactions are occurring, making the currency more valuable. Conversely, if oil performs poorly, so does the Canadian dollar. Overall, this means CAD shares a positive correlation with oil.
Analysts have also pinpointed the positive relationship between oil and CADJPY, which has to do with Japan being a significant importer of the commodity.
Australian dollar/New Zealand dollar and gold
While iron ore is technically Australia’s most exported product, gold has historically been the fifth or sixth after, contributing to around 5% of the country’s total exports.
Moreover, accessing the price action for gold is more accessible, and most mainstream media will regularly publish news about it. Regardless, Australia usually ranks in the top 5 for the largest exporters of this precious metal.
Therefore, the Australian dollar (AUD) has a positive correlation with gold. If demand for the latter grows, it means more AUD-denominated deals, making this currency more valuable and increasing the price of AUDUSD; the opposite is true.
The reason NZD (New Zealand dollar) is closely correlated to gold is because the country is the closest trading pattern to Australia, given their geographical proximity. Therefore, the economies of both countries, along with their respective currencies, often move in tandem with each other.
The dollar’s influence on commodities
Everyone knows the United States dollar is the world’s reserve currency. Therefore, virtually all currency exchanging and global transactions begin with the greenback.
Hence, most commodities will be priced against USD by default, resulting in a number of fairly predictable outcomes. Let’s take the price of XAUUSD (gold). When gold’s value increases, it could mean several things.
The first instance is there might obviously be more demand for gold from a production perspective, consequently crippling the dollar. This weakening could be felt to some extent with a host of USD-based pairs.
The other common relationship between the dollar and gold is during stressful economic periods. In other cases, XAU may rise when investors want to invest in a ‘safe haven’ due to the long-held perception of gold being a value storer during recessionary times.
So, the general correlation between commodities and the dollar is inverse for reasons mostly to do with production and economic cycles. Therefore, while we have listed the classic commodity-currency connections in the previous section, traders can never ignore USD in the conservation.
Final word
Understanding the impact of commodities in forex isn’t something to be observed by only forex traders but also long-term or position commodity traders. The latter group could consider using currencies as a proxy alternative since this market may provide carry trade or interest-bearing opportunities.
Although no profitable carry trades presently exist with any of the currencies we’ve covered here, this can change at any time, depending on central bank decisions. So, in simpler terms, instead of buying gold from a commodities broker, traders might instead trade AUDUSD if we know each of these follow similar price patterns.
Yet, the difference is one could earn overnight interest or swaps where they would have been perhaps charged by trading the actual commodity. Therefore, as a commodities trader, you should periodically look at markets like CADJPY, AUDUSD, NZDUSD, and USDCAD for any potential carry trade opportunities.
For the rest of the traders, it certainly won’t hurt to be informed on the commodities we’ve spoken about here. What’s worth noting is while the relationships between the former and particular currencies are time-tested, correlation can ‘go out of sync’ without warning, particularly in the short term.
Situations can change, and, as with most things in forex, the market is dynamic and may not necessarily move predominantly according to a historical correlation.
