One of the strongest market correlations is between currencies, mainly the American dollar, and commodities. Why such a strong relation? Commodities are quoted in U.S dollars on global commodities exchange markets and any depreciation of the USD causes increased demand since commodities become cheaper for investors trading in other currencies like the Euro or the Jen. On a simple example on oil I will show you how it works.
Assumptions:
1 barrel of Brent oil = 90 USD
USD/JPY = 110
Cost of 100 barrels in USD = 100 x 90 USD = 9,000 USD
Cost of 100 barrels in JPY = 9,000 USD x 110 USD/JPY = 990,000 JPY
Now let’s assume that after some time the American dollar weakened:
USD/JPY = 105 so then:
Cost of 100 barrels in USD = 100 x 90 USD = 9,000 USD
Cost of 100 barrels in JPY = 9,000 USD x 105 USD/JPY = 945,000 JPY
Summarizing:
USD/JPY = 110
Cost of 100 barrels in JPY = 9,000 USD x 110 USD/JPY = 990,000 JPY
USD/JPY = 105
Cost of 100 barrels in JPY = 9,000 USD x 105 USD/JPY = 945,000 JPY
Difference = 45,000 JPY
A weaker American dollar causes increased demand for oil and that in turn causes the price of the “black gold” to go up.
The correlation between the U.S dollar and oil is pictured on the graphs below. Graph 1 represents EUR/USD on a daily interval while graph 2 show oil on a daily interval. Please notice the similarity of both graphs. When the EUR/USD increases (the dollar loses value) the price of oil goes up, when it declines, oil goes down. Keep in mind that this example shows a simple relation of the value of the USD to the prices of commodities. Of course, there are many more fundamental factors that affect the prices of commodities. But, when keeping other things constant, with no important macroeconomic publications, the dollar certainly affects the direction of commodities prices.
Graph 1
Graph 2
Feel free to contact me with any question or comments.
Adam Narczewski
X-Trade Brokers Dom Maklerski S.A.
adam.narczewski@xtb.pl