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How Commodities Affect the Currency Prices
Written by: PaxForex analytics dept - Friday, 15 July 2016 0 comments
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.
The currency prices are affected by many outside influences, including interest rates, economics, capital flows and commodity prices. In general, the more dependent a country is on a specific commodity, the stronger the correlation between the currency and the commodity. Certain countries' currencies will fluctuate with movements in commodity prices based on whether the country is a net importer or exporter of the commodity in question.
When a country is heavily dependent on a commodity, changes in the price of the commodity can have a substantial effect on the country's currency. For example, Norway is the fifth-largest oil producer in the world and
the krone is highly correlated to crude oil prices. As the price of crude oil increases the value of the krone generally increases. Other oil-producing nations, including Canada, also experience this effect on their currencies.
When the domestic economy is greatly affected by commodity price shifts, then the currency is especially vulnerable. Even for nations whose currency is strongly correlated with commodity pricing, different commodities will affect the currency differently (or perhaps not at all). By knowing which commodities are strongly correlated to which countries, an currency trader can better predict how commodity price shifts will affect currency exchange rates.
Currency traders can indeed predict (with great reliability) currency rates based upon commodity price shifts. Investors who speculate on the currency and commodity markets will look for opportunities to trade currency pairs and commodities that are highly correlated. Highly correlated securities usually move in tandem. When the relationship breaks down, some investors look at that scenario as an anomaly that will correct itself.