What is Commodity Forex?
let’s see the commodities and how they relate to commodity currencies. In this crazy trading universe that we call forex, the commodity currency is a currency whose exports from those countries are mostly raw materials (precious metals, oil, agriculture, etc).
There are dozens of countries that fit this description, but the most traded currencies are the New Zealand Dollar, Australian Dollar, and Canadian Dollar, all of them can be found in the forex market. Because their currencies are all called dollars, which are also known as commodity dollars or “Comdolls” for short.
Those three currencies are some of the top currency pairs you can find in the forex market, which means they have great liquidity and volatility to trade.
How do commodities affect commodity currencies?
The exports of raw materials that are a large part of these countries, an increase in the prices of commodities can cause an increase in the value of the country’s currency, and vice versa. Let’s see the main commodity currencies that you can find in any of the forex brokers, and how they correlate with certain commodities (raw materials):
Canadian Dollar (USD/CAD) and Oil
Oil is the life blood of the industrialized world, therefore, it is a highly traded commodity and most traders are very attentive to its price.
Canada is one of the world’s largest oil producers and is second in oil reserves, Saudi Arabia being the first. This makes Canada very dependent on its most precious commodity. It is also the largest supplier to the world’s largest consumer (black addicts), the United States. Oil is a big part of the US economy, rising oil prices tend to have a negative effect on US stocks and the US dollar.
Rising oil prices tend to be good for Canada and bad for the US, while falling oil prices tend to be bad for Canada and good for the US. How can we play with this idea in the Forex market? Let’s see a chart of oil prices and the USD/CAD (Canadian dollar):
As you can see from the chart above, the price movement of USD/CAD (Canadian-dollar) and oil are inversely correlated with each other, which means that oil is trending up, USD/CAD is trending down. down and vice versa.
Since January 1988, USD/CAD and oil have been roughly 68% inversely correlated with each other. This is a very strong correlation. As a forex trader, you have another tool to add to your USD/CAD analysis toolbox and help you make better long-term trading decisions.
Australian Dollar (AUD/USD) and Gold
Everyone appreciates gold. It is metal, shiny and makes very good jewelry. In addition to that, gold is used in many applications such as: power cable, coating, and in dentistry.
In the financial world, gold is seen as a safe haven against inflation and is one of the most traded commodities. Well, how does all this relate to the Forex market? To answer that question, let’s look at the Australian dollar.
For many traders, trading the Australian dollar is the same as trading gold. Australia is one of the world’s largest gold producers and its exports represent more than 50% of commodities, including precious metals.
These commodities make up a large portion of Australia’s Gross Domestic Product, so many traders are watching the ups and downs of commodity prices, especially gold, which can influence the direction of the Australian dollar. Let’s look at a comparative chart of gold and the “Aussie”.
This is a monthly chart comparing the price movement of gold and AUD/USD from early 1980 to early 2006. As you can see, the two movements are pretty much the same, and from January 1980 to January 2002 you can see gold as a leading indicator of AUD/USD.
On the chart we see “red stars” above the major gold turning points, these turning points appear to occur before the major AUD/USD turning points. This relationship has changed in 2002, as the movement of gold and AUD/USD were practically the same, until gold skyrocketed in value in 2005 and 2006.
As we have learned with oil and USD/CAD, traders can watch gold prices to gain an extra edge in AUD/USD analysis. Gold moves may give possible clues to the direction of AUD/USD, and this may be cause for analysis. For those who cannot trade gold directly, the strong AUD/USD correlation is a great replacement. You can trade AUD/USD on the forex market as a replacement for gold, which is listed on the futures market.
New Zealand Dollar (NZD/USD)
Like its neighbor Australia, New Zealand’s economy is also driven by commodity exports which are a large part of its exports. While most traders see the Kiwi as not directly tied to a certain commodity, its correlation with commodities in general is important.
As of January 1990, its correlation is over 63%, compared to the Commodity Research Bureau Index (CRB Index), which is one of the world’s standard indices of commodity prices.
This chart shows how commodity prices and the New Zealand Dollar have both moved in tandem over the last 25 years.
Since January 1990, the NZD/USD and the CRB Index have been approximately more than 60% correlated. As prices go up and down, traders can look for similar moves in the NZD/USD, as New Zealand relies on commodity exports.
Like gold and oil, traders can express their perspectives and ideas on commodities by trading and analyzing the NZD/USD.
Commodity Forex Conclusion
Short-term movements in commodities generally do not directly affect a commodity currency immediately. When analyzing commodities for use with currencies, it is probably best suited for long-term perspective investing or trading.
Keep in mind that even though we see strong correlations between commodity currencies and commodities, exports are only one part of a country’s economy. You always have to see the country’s economy, interest rates, and also the political situation as a whole.
The combination of all these aspects and including the movements of commodities, can give you a clearer picture and possibly better ideas and analysis in currency trading (Forex market). With the leverage and liquidity advantage available in Forex, Forex can be a great alternative to trading following commodities or hedging commodity investments.
Sounds interesting to you, right? Keep learning trading with DTP with upcoming articles on our Blog.