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How to Trade Currency and Commodity Correlations
How to Trade Currency and Commodity Correlations

How to Trade Currency and Commodity Correlations

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How to Trade Currency and Commodity Correlations

Being aware of a correlation, monitoring it and timing it are crucial to successful trading based on the inter-market analysis provided by examining currency and commodity relationships. A commodity currency is a form of money that enjoys a close relationship with the value of a particular commodity. Investors look at commodity currencies as national currencies that are closely tied to price changes for a commodity that happens to be a majority export of the nation in question. Commodity currency trading offers the investor the chance to make a play on specific commodities indirectly through the holding of a foreign currency. Figure 5 shows the weekly CAD/JPY as well as the correlation indicator (15 periods) comparing it to oil futures. Much of the time the indicator shows a strong correlation in the 0.80 area, yet there are times when the correlation falls off.

If you’re making 7% per year on the financial asset, but the currency is falling relative to your domestic currency by more than 7% per year, you’re losing money. In a separate article, we looked at the influence of a country’s current and capital accounts on the value of its currency. They are global reserve currencies (to varying degrees) and often act as reference currencies in FX pairs.

Trading this pair is also known as trading the “loonie.” Canada’s proximity to the U.S. means the two economies are closely tied, which shows in the export totals, with 75% of Canadian exports going to the U.S. in 2019. As seen in Figure 3, as the demand for a commodity shifts in (less demand) the quantity decreases to q’. This decreased demand is likely to decrease GDP, as less exporting takes place, as demonstrated by the equation for GDP below.

New Zealand has a solid connection to gold and will react to movements in the commodity’s price. Trading the New Zealand dollar to the U.S. dollar (NZD/USD) is also known as trading the “kiwi.” Also adding to the liquidity of commodity pairs is the stability of their economies, which back the currencies. These characteristics make commodity pairs attractive to traders who want to have the potential for profits while moving in and out of trades quickly. As a result, its economy is impacted by the price of gold and how much it can export. New Zealand is a major trading partner with Australia and is thus highly susceptible to fluctuations in Australia’s economy.

  1. While these currency pairs are worth watching for their high correlation tendencies towards a commodity, there will be times when the strong correlation does not exist and may even reverse for some time.
  2. Several types of commodity money were sometimes used together, with fixed relative values, in various commodity valuation or price system economies.
  3. New Zealand is a major trading partner with Australia and is thus highly susceptible to fluctuations in Australia’s economy.
  4. As a net oil exporter, Canada is severely hurt by declines in the price of oil, while Japan—a major net oil importer—tends to benefit from oil declines.

Traders need to take into account commissions and spreads, additional fees, liquidity and also access to information. Currencies and commodities that are heavily traded will be easier to find information on, will have smaller spreads and liquidity that is more likely to be adequate. As these currencies tend to be highly sensitive to commodity price fluctuations, they can provide valuable insights into the health of the global economy and the demand for essential goods. Safe-haven commodity currencies are those that investors turn to in times of wider-than-normal market expectations or market volatility. A commodity currencies basket is a collection of currencies from countries that are major commodity exporters. Investors/traders often consider commodity currencies when making decisions in the equity market.

FAQs – Commodity Currencies

This type of currency is different from fiat money, which has no intrinsic value and is not backed by a physical commodity. A commodity-backed currency is a currency that is directly pegged to the value of a specific commodity, such as gold or oil. These currencies serve as an important link between the global demand for commodities, the supply chains of them, and the economic health of resource-rich countries. If you’re a commodity trader looking for a bit of a change, commodity currencies such as the AUD/USD and CAD/JPY provide opportunities worth looking into.

What Are the Commodity Pairs?

While the correlation is not perfect, major up moves in oil (blue) are typically followed by a rise in the CAD/JPY, and declines in oil are typically followed by declines in the CAD/JPY. Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, hon is its stock price a worthy investment learn more retirement, insurance, and financial planning. Radford documented the way that this ‘cigarette currency’ was subject to Gresham’s law, inflation, and especially deflation. There are several actions that could trigger this block including submitting a certain word or phrase, a SQL command or malformed data. The following chart shows the CHF/USD (inverted USD/CHF; red/green line) to the price of gold (blue line).

Due to the slightly delayed impact of these movements on the currency market, there is generally an opportunity to overlay a broader movement that is happening in the commodity market onto that of the currency market. It never hurts to be more informed about commodity prices, and how they drive currency movements. While the correlations (positive or negative) can be significant, if forex traders want to profit from them, it’s important to time a “correlation trade” properly. There will be times when a relationship breaks down, and such times can be very costly for a trader who does not understand what is occurring.

Commodity currency

The country also exports petroleum and gold, and its currency is, therefore, heavily dependent on these commodity prices. Besides being a commodity currency pair, Australia also provides investors with insight as to how well China’s economy is performing since China is the largest export customer of Australia. If Australia is increasing its exports to China, it’s reasonable to conclude that economic growth is picking up in China. A strong Chinese economy bodes well for the rest of the world as well as Australia, which can increase the Australian dollar exchange rate due to the increase in demand for Aussie goods. Commodity pairs offer benefits to investors because they are among the most widely traded currency pairs on the foreign exchange (FX) market.

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Other currency commodity relationships can be found by looking for major producers of any export, as well as the major importers of the same commodity. The currency cross rate between the exporter and importer is worth looking at for a correlation with the commodity. While Australia was among the smaller volume oil exporters in 2009, throughout 2010 the AUD/USD was also positively correlated to oil prices, and then in September diverged. Yes, a commodity currency generally refers to the currency of a country that relies heavily on the export of commodities, such as energy resources, metals, or agricultural products. Commodity currency pairs are forex pairs that involve at least one commodity currency.

The evaluation of commodity currencies reflect how today’s modern investors assign different kinds of abstract values to specific national monetary forms. For example, traders also refer to “hard” and “soft” currency, where hard currency is seen as a stable investment in the global economy as a whole, and soft currency is something experts often recommend avoiding. In a similar way, making a national currency a “commodity currency” reflects a fixed thinking about the value of that particular money, in relation to the nation’s exports. Looking at this from a net oil exporter/importer perspective, the currency pair that tops the list of currencies to trade to express a view on oil prices is the Canadian dollar against the Japanese yen. The chart below illustrates the tight correlation between oil prices (blue line) and CAD/JPY (red/green line).

How to Trade Currency and Commodity Correlations

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