Chapter 18. Commodity currencies at Forex (Commodity currencies)

As we have already seen in the previous chapters, the price of a currency is determined by many factors, including economic, political, psychological and a number of others. All of these factors affect the exchange rate of each country to a greater or lesser extent – some factors to a greater and some to a lesser extent. But at the Forex market there are currencies, the price of which is almost completely determined by the only factor – the export of its country. Such currencies at Forex are called commodity currencies.

 

The specificity of commodity currencies is that the economy of their countries is almost entirely based on the export of certain raw materials – oil, gas, precious metals, agricultural products. There are many countries that fall under this definition, but the main ones are Canada, Australia and New Zealand. Since the currency of these countries is the dollar (each country has its own), in this context they are called commodity dollars (comdolls). The fact that the export of raw materials is a determining factor in the health of the economy of these countries, the increase in the price of the corresponding raw materials on the world market leads to the growth of the national currency, and vice versa. Therefore, it is customary to speak about correlation (interrelation) of the cost of raw materials on the world market with the price of commodity currency.

The Canadian dollar (CAD), Australian dollar (AUD) and New Zealand dollar (NZD) are among the major currency pairs traded on Forex, so studying their features as commodity currencies is an integral part of successful work on the currency market. Below we will look at each commodity currency separately and give comments on each of them.

Canada is famous for its oil reserves, which are second only to those of Saudi Arabia. Oil is commonly referred to as “black gold”, which indicates the high demand for this resource on the world stage. Thus, due to its favorable geographical position, Canada is the largest exporter of oil in the world. The USA, on the contrary, lacks this resource and is its largest importer. Therefore, changes in oil prices affect the USD/CAD exchange rate in the opposite proportion. An increase in oil prices leads to a fall in USD/CAD (cheapening of the US dollar). A fall in oil prices, on the contrary, leads to an increase in USD/CAD (appreciation of the dollar). Therefore, it is common to talk about an inverse correlation between the oil price and the USD/CAD exchange rate. Since January 1988, the oil price and the USD/CAD exchange rate have had more than 68% inverse correlation – that’s a pretty strong relationship! Knowing this fact can be a good additional tool in predicting changes in the USD/CAD exchange rate in the Forex market. Below is a graph where you can observe the correlation between oil price and USD/CAD exchange rate from January 1988 to January 2006.

Australia’s economy is heavily dependent on the export of gold products and jewelry, which accounts for more than 50% of the country’s total exports. This is due to the gold deposits that Australia is endowed with due to its favorable geographical location. The world gold price and the AUD/USD exchange rate have an even greater correlation than the world oil price and the USD/CAD exchange rate. From January 1980 to 2006, the fluctuations in the AUD/USD exchange rate and the gold price were almost identical, as can be seen in the graph below. Moreover, there was a tendency that the reversal of gold rates slightly preceded the corresponding reversal of the AUD/USD exchange rate – the asterisks on the chart mark the points of reversal of rates, which clearly show this. The correlation reversed in 2005-2006 when gold rose significantly in value and there was no corresponding appreciation of the Australian dollar (AUD) against the US dollar (USD). Nevertheless, in the long term, the correlation still holds and can be used as an additional forecasting tool in Forex. It should be known that the world gold price and AUD/USD currency quote have a direct correlation.

New Zealand’s economy, like that of its western neighbor, is heavily dependent on exports. But, unlike Australia and Canada, New Zealand’s exports are not dominated by any one type of raw material. The country exports dairy products, meat, fish, timber, wool and others. Because of such a variety of raw materials sold by the country, the Commodity Research Bureau Index (CRB Index) is used to determine the correlation between the value of export goods and the exchange rate of the national currency against the U.S. dollar. This index is represented by a basket of the world’s leading commodities and is also an indicator of inflation growth in the world. The CRB Index and the NZD/USD exchange rate have a direct correlation. Below is a graph showing about 60% of this correlation from January 1990 to January 2006. As can be seen, the NZD/USD exchange rate is highly dependent on world commodity prices. Knowing this fact can serve as an additional tool in the arsenal of Forex analysis and forecasting tools.

To summarize the chapter, it is worth noting that the correlation between commodity prices and commodity currencies should be taken into account in forex trading only in the medium and long term. It should also be remembered that exports are only a part of a country’s economy. In the process of making a decision on opening or closing a position on commodity currencies at Forex, it is necessary to take into account other factors affecting the economy of the country, such as, for example, the following, refinancing rate, political situation in country etc.