It is widely known that economic growth and exports are directly related to a country's domestic industry, so it is natural for some currencies to
be heavily correlated with commodity prices. The three currencies with the tightest correlations to commodities are the Australian dollar, the
Canadian dollar and the New Zealand dollar. Other currencies that are also impacted by commodity prices but have a weaker correlation are
the Swiss franc and the Japanese yen. Knowing which currency is correlated to which commodity can help traders recognize and predict
market movements. Here we will look at currencies correlated with oil and gold and show you how you can use this information in your trading.
ABC Group Limited Oil and the Canadian Dollar
Over the past few years, the price of commodities has fluctuated considerably. Oil, for example, surged from $60 a barrel in 2006 to a high of
$147.27 a barrel in 2008 before plummeting back below $40 a barrel in the first quarter of 2009. Similar volatility has been seen in the price
of gold. Knowing which currencies are affected by what commodities will help you make more educated trading decisions.
Oil is one of the world's basic necessities - at least for now, most people in developed countries cannot live without it. In February 2009, the
price of oil was nearly 70% below its all-time high of $147.27 set on July 11, 2008. A drop in oil prices is every oil producer's nightmare, while
oil consumers enjoy the benefits of greater purchasing power. This is a complete 180-degree change from the situation at the beginning of
2008, when record-high oil prices had oil producers doing back-flips while forcing consumers to pinch pennies. There are a number of
reasons to explain the fall in oil prices, including a stronger dollar (since oil is priced in dollars) and weaker global demand. As a net oil
exporter, Canada is severely hurt by declines in oil, while Japan - a major net oil importer - tends to benefit.
Between the years 2006-2009, for example, the correlation between the
Canadian dollar and oil prices was roughly 80%. On a day-to-day basis,
the correlation will often break, but over the long term it has been strong
because the value of the Canadian dollar has good reason to be sensitive
to the price of oil: Canada is the seventh-largest producer of crude oil in
the world and continues to climb up the list, with production in oil sands
increasing regularly. In 2000, Canada surpassed Saudi Arabia as the
United States' most significant oil supplier. Most are unaware that the
size of Canada's oil reserves is second only to those in Saudi Arabia.
The geographical proximity between the U.S. and Canada, as well as
the growing political uncertainty in the Middle East and South America,
makes Canada one of the more desirable locales from which the U.S.
Figure 1: A look at the correlation between the price of oil and the price action in the CAD/USD from
January 2005 to March 2009
Figure 1 shows the positive relationship between oil and the Canadian loonie. In fact, it should come as no surprise that the price of oil
actually acts as a leading indicator for the price action of the CAD/USD. Since the traded instrument
is the inverse, or USD/CAD, it's important to note that based on the historical relationship, when
oil prices go up, USD/CAD falls and when oil prices go down, USD/CAD rises.
Oil and the Japanese Economy
At the other end of the scale is Japan, which imports almost all of its oil (compared to the U.S., which imports approximately 50%). As of
2009, it is the world's third-largest net oil importer behind the U.S. and China. Japan's lack of domestic sources of energy, and its need to
import vast amounts of crude oil, natural gas and other energy resources, make it particularly susceptible to changes in oil prices. Therefore,
when oil prices rise dramatically, the Japanese economy suffers. (Hedge against rising energy prices and diversify your portfolio; read ETFs
Provide Easy Access To Energy Commodities.)
ABC Group Limited An Attractive Oil Play: CAD/JPY
Looking at this from a net oil exporter/importer perspective, the currency
pair that tops the list of currencies to watch is the Canadian dollar
against the Japanese yen. Figure 2 illustrates the tight correlation
between oil prices and CAD/JPY. As with the USD/CAD, oil prices tend to
be the leading indicator for CAD/JPY price action with a noticeable delay.
As oil prices continued to fall during this period, CAD/JPY broke
the 100 level to hit a low of 76.
Figure 2: A look at the correlation between the price of oil
and the price action in the CAD/JPY from January 2005 to
ABC Group Limited Gold
Gold traders may also be surprised to hear that trading the Australian
dollar is just like trading gold in several ways. Australia is the world's
third-largest producer of gold, and the Australian dollar had an 84%
positive correlation with the precious metal between 1999 and 2008.
Generally speaking, this means that when gold prices rise, the Australian
dollar appreciates as well. The proximity of New Zealand to Australia
makes Australia a preferred destination for exporting New Zealand goods.
Therefore, the health of New Zealand's economy is very closely tied to
the health of the Australian economy, which explains why the NZD/USD
and the AUD/USD have had a 96% positive correlation over the same
time period. The correlation of the NZD/USD with gold is slightly less
than that of the Australia dollar but it remained strong at 78%.
Figure 3: A look at the correlation between the price of gold and the price action in the NZD/USD from January
2005 to March 2009
A weaker, but still significant, correlation is that of gold prices and the Swiss franc. Switzerland's political neutrality and the fact that its
currency used to be backed by gold have made the franc the currency of choice in times of political insecurity. From January 2006 until
January 2009, USD/CHF and gold prices had a 77% positive correlation. However, the relationship broke down somewhat
in September 2005 as the U.S. dollar decoupled from gold price movements. (For further reading, see
The Gold Standard Revisited and What Is Wrong with Gold?)
Trading Currencies as a Supplement to Trading Oil or Gold
For seasoned commodity traders, it may also be worthwhile to look at trading currencies as a substitute or a complement to trading
commodities. In addition to being able to capitalize on a similar outlook (e.g. higher oil), traders may also be able to earn interest if they are
on 2% margin or higher with most brokers. When trading currencies, you are dealing with countries, and countries have interest rates, of
course. For example, a trader who may have bought the AUD/USD in March 2009 would be able to earn up to 3% in interest income if
Australian interest rates remained at 3.25% and U.S. interest rates remained at 0.25% for the entire year. These are unleveraged rates,
which means that with 10 times leverage, for example, net of any exchange rate adjustments, the interest income would be that much
higher. Leverage also makes the trade riskier, which means that if the trade turns against you, losses could add up.
Along the same lines, if you shorted AUD/USD to play a short gold view, you would end up paying interest. If you're a commodity trader
looking for a bit of a change from the usual pro-gold trade (for example), commodity currencies such as the AUD/USD and NZD/USD
provide good opportunities worth looking into.
If you want to trade commodity currencies, the greatest way to use commodity prices in your trading is to always keep one eye on movements
in the oil or gold market and the other on the currency market to see how quickly it responds. Due to the slightly delayed impact of these
movements on the currency market, there is generally an opportunity to overlay a broader movement that is happening in the commodity
market to that of the currency market. Bottom line: It never hurts to be informed about commodity prices and how they drive currency
movements. (For more insight, read The Currency Market Information Edge and Forex: Wading into The Currency Market.)
One of the long-term trends facing our planet is the fact that our world population continues to grow at a rapid pace. The United Nations
predicts that the global population will increase by 11% leading up to the year 2020, and will jump by 20% by the time we hit 2030. This
population growth will continue to place a greater strain on the limited supplies of the world's natural resources. Metals and other materials
will be needed to build vital infrastructure. Vast amounts of energy resources are needed to provide electricity and to power western-style
transportation. Tons of soft and agricultural commodities will be required to meet the world's growing middle-class demand for meat and
other foods. As emerging and frontier markets continue to grow, commodities sector will continue even more important.
In order to facilitate the use and trade of various commodities, exchanges have been set up to allow participants to buy and sell these critical
natural resources. Futures and spot prices for items like crude oil, corn, gold and others are now commonly priced for
end-users and speculators, alike.
However, not all natural resources can be found on these exchanges. As our global population continues to grow, growing demand for these
"other" commodities is almost assured. In due time, we could see them trading on the NYMEX or the Chicago Board of Trade. Here's a list
of some of commodities of the future.