Commodity Prices And Currency Movements

Predicting the next move in the markets is the key to making money in trading, but putting this simple concept into action is much harder than it sounds. Professional forex traders have long known that trading currencies requires looking beyond the world of FX. The fact is that currencies are moved by many factors — supply and demand, politics, interest rates, economic growth, and so on. More specifically, since economic growth and exports are directly related to a country’s domestic industry, it is natural for some currencies to be heavily correlated with commodity prices. The top three currencies that have the tightest correlations with 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 with what commodity can help traders understand and predict certain market movements. Here we look at currencies correlated with oil and gold and show you how you can use this information in your trading. (For background reading, see The Most Popular Forex Currencies .)

Oil and the Canadian Dollar Over the past few years, the price of commodities has fluctuated significantly. 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 and rising to above $80 in 2011. Similar volatility can be seen in the price of gold, which hit $1600 an ounce in June 2011 and then a new high of over $1,800 an ounce a few months later in August 2011. 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. (Find out how the everyday items you use can affect your investments in Commodities That Move The Markets .)

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 decline in oil prices is a nightmare for oil producers, 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 put a big smile on the faces of oil producers while forcing oil consumers to pinch pennies. There are a number of reasons to explain the fall in oil prices, including a stronger dollar (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 approximately 80%. On a day-to-day basis, the correlation can 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. Unbeknownst to many, 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 places from which the U.S. can import oil. But Canada does not service only

U.S.

demand. The country’s vast oil resources are beginning to get a lot of attention from China, especially since Canada stumbled upon a new stash of oil after a reclassification of its Alberta oil sands to the economically recoverable category. (Read more in Peak Oil: What To Do When The Wells Run Dry .)

Figure 1 shows the clearly 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.