Forex and commodities are often treated as two completely separate and unrelated instruments – there are forex traders, and there are commodity traders. And if you are trading strictly on technicals, that separation makes sense; commodities behave quite differently than currencies.
But looking at it from a fundamental standpoint, commodities and forex are intimately linked – something that some traders don’t consider, and that you might leverage to your trading advantage.
It’s All Gold
Historically, commodities and currencies were not only connected, and they were the same thing: gold is a good example. Until virtually all countries moved off of the gold standard, money was just a way to measure how much gold you had. Most of the names for currencies derive from weights, used to measure what we call commodities today. Peso, for “weight”; or a pound sterling was literally a pound of silver.
But that was then. What about now?
Well, there are currencies that we associate with commodities, to the point of calling them commodity currencies. The AUD, for example; Australia exports a lot of raw materials, and therefore the prices of those materials impact the value of their dollar.
Then there is the practice of using commodities in lieu of currency, which isn’t so common in the West but happens to be quite popular in China and India.
Though the latter tends to focus on gold, many major Chinese corporations use commodities as a store of value and will even trade contracts as payment for services. It was this demand for a store of value that drove the price of copper up over the last decade, or so. With hundreds of billions of dollars worth of commodities being used as a form of currency, this naturally will have an impact on money markets.
How Can a Trader Use This Information?
Beyond just looking at commodity currencies and considering the prices of the raw materials they export, think of all currencies being impacted to some degree by the prices of commodities.
After all, they are the basic building blocks of everything the economy does, so the natural variation of prices in raw materials will translate into economic effects. Those effects, however, can be varied.
It’s time to think a little bit out of the box in how commodities might have an impact on currencies (and vice versa).
Gold: the Standard
Traditionally, traders look at gold as a bellwether of world economic health, and the effect on currencies in that respect: for example, higher gold prices reflect risk-off sentiment and support for safe-haven currencies.
But gold is also used as a reserve for central banks, which will typically start buying – and diminishing their cash reserves – when the price goes below certain thresholds. It’s also in high demand in places where people have low confidence in their currency, such as India and China as mentioned previously – good economic performance in those countries can drive up gold prices, contrary to conventional wisdom.
Agricultural Commodities, (particularly corn)
You’d be surprised in how many things corn is used, from feed to upholstery to the manufacture of penicillin, corn is very useful.
If prices of this base commodity go up, then so does the cost of a myriad of other products, which will A) impact inflation, and B) slow the economy, and affect corporate profits.
Countries that produce their own supply will mostly be unaffected, countries that export will see benefits, and those that depend on imports will likely see their currency weaken as they have to spend more to not only feed their population but by the products that rely on corn to be made.
Oil and Natural Gas
Oil and natural gas are the important price component of transportation. Higher oil prices, especially bunker fuel, make shipping more expensive, and slow international trade – and that translates into currency impacts.
Metals (of the non-precious sort)
One of the metals most used in housing construction for electrical wires and fittings is copper. A drop in copper prices not only affects the countries that export copper, but also the countries that buy it – such as China and the US.
More expensive copper means more of their currency is being directed away from non-copper producing sources, which could lead counterintuitively to relatively higher values for the currency. Copper is often found in conjunction with molybdenum, silver, and gold.
Another metal that could have similar effects and is getting more attention lately is cobalt; essential for the production of lithium-ion batteries – the ones used for cell phones and electric car batteries.
Developed economies spend more on high technology, and therefore those currencies would be more vulnerable to price increases in cobalt than emerging economy currencies.
Rarely do these fluctuations in commodities have a major, immediate impact on a currency pair, but they can inform longer-term trends as analysts and traders can pick up on the underlying effect that is being missed by the broader market and capitalize on it. If it’s not immediately obvious why a particular currency is behaving a certain way, don’t discount commodities as potentially affecting – even if it’s not a “commodity currency.”
The post The Forex Commodities Connection appeared first on Orbex Forex Trading Blog.