Since many Forex “strategies” are little more than veiled attempts to get your hard-earned cash, an understanding of fundamentals is important. While different strategies have their place, understanding the global commodities markets and their effects on the value of various currencies can give an edge up and allow the holy grail–prediction of currency moves. So let’s dig in to see the effect of two commodities on specific foreign currencies. We will concentrate on two, oil and gold.
Oil
Perhaps you’ve noticed the wild ride crude oil has had-and the dramatic effect this had on your wallet when filling up. Gone are the $2 / gallon days of 10 years ago. Crude oil prices hit their peak in 2008 at over $147 a barrel before dropping to $40 a barrel a year later, to rising to where they are now at $110 a barrel. In the last year alone, they have fluctuated between about $20 per barrel, giving opportunities in the Forex market. As investopedia puts it,
With many countries around the world in recession, the trend of commodity prices can mean the difference between a deeper downturn and a faster recovery. Knowing which currencies are affected by what commodities will help you make more educated trading decisions.
Canada produces more oil than it uses, making it a net exporter. Right now, it is number six in rank of the world’s largest producers of oil, putting it ahead of Iraq, the United Arab Emirates, Venezuela, Mexico, and Kuwait. It is also increasing production, as more advanced mining techniques such as cyclic steam stimulation and steam assisted gravity drainage have made exploitation of bitumen oil sands commercially feasible-something not true even in the recent past. The fact that the Canada has now become the United States’ greatest foreign supplier of oil-surpassing Saudi Arabia is also a factor for Forex traders. Because of the increasing tensions on the Asian continent, primarily in the Middle East, Canada, in the United States’ back yard, is the preferred source of oil. Very interestingly, with the recent mining techniques now available, Canada has the second largest oil reserves in the world, only surpassed by Saudi Arabia itself. With the heavy industrial growth in China, Canada is attracting another vast customer base.
With its status as a net exporter, a decrease in oil price has a marked effect on the value of the Canadian dollar. In the latter half of the 2000s, the correlation between oil prices and the Canadian dollar was about 80%, making oil price a strong predictor of Canadian currency value. When you look at a chart of crude oil on top of the Canadian Dollar, it is easy to see how price fluctuations in crude oil prices lead changes in the price of the Canadian Dollar-giving a remarkable edge to the trader who is paying attention.
To take an example of how, for example, a natural disaster can affect crude oil prices, look at 2005. The volatility was massive. As investorguide.com reports:
The apex of crude prices was reached soon after Hurricane Katrina and prices began dipping soon afterward. By the time December 31st rolled around, the final price of crude settled at 40% above what it began 2005 with.
Another foreign currency heavily tied to oil is the Norweigian krone. Norway is a large producer of oil, and so the value of the krone is highly dependent on the movement of the price of oil, just as in Canada.
Japan, on the other hand, is a major importer of oil, getting 99% of it from outside its borders. Since it has to purchase all this oil, increases in oil prices has a significant negative effect on the economy as the country has less money available. Nuclear power helped somewhat in the past (despite the high cost of importing uranium), but with the recent problems with the Fukushima nuclear plant and the subsequent shutdown of all nuclear facilities in the country, Japan’s reliance on foreign oil has only increased. The takeaway here is that increases in crude oil prices have a marked effect on the Japanese economy with the resultant decrease in the value of the Yen.
Gold
The Australian Government reports:
Gold is one of Australia’s top 10 commodity exports and is worth about $14 billion per year…Australia is estimated to have about 11 per cent of the world’s Economic Demonstrated Resources (EDR) of gold, the second largest after Chile and ahead of Russia, the USA and Indonesia.
With these large gold reserves, it is no surprise that there was an 85% correlation in the price of gold compared to the Australian Dollar from 1999 to 2008. More recently, The Australian reported that from January to June of this year,
The correlation between the Australian dollar and gold has been trending steadily higher for three months and is now at 0.89. Given the correlation, a rise in the price of gold would do wonders to boost the fortunes of the dollar.
Another interesting correlation tied to gold is that of the New Zealand dollar. It is obvious that the Australian dollar would be affected by the price of gold, but because of its proximity to Australia, New Zealand is its largest trading partner. When the price of gold goes up, New Zealand will export more of its good to the Australians. Conversely, when the value of the Australian Dollar goes down, New Zealand exports will decrease. Since Australian accounts for so much of New Zealand’s exports, fluctuations in the price of gold can have an even larger effect on the New Zealand Dollar than on the Australian dollar.
Commodities Tied to Dollars
Some commodities are typically priced in dollars. When the price of a given commodity rises, this has the effect of increasing the value of the dollar. For the price of a specific commodity to continue the same in another currency, the competing currency will also have to increase in value. For example if crude oil increases by 5% in dollars, the price of oil in terms of the Yen will have to increase the same percentage. This can present an interesting possibility on a dollar/yen play if this does not happen in this case, for example.
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