What is a commodity currency?
In this crazy trading universe we call the Forex, a commodity currency is a currency whose country's exports are largely comprised of raw materials (precious metals, oil, agriculture, etc.).
There are dozens of countries that fit this description, but the most actively traded currencies are the New Zealand Dollar, Australian Dollar, and the Canadian Dollar. Because their currencies are all called dollars, they are also known as the commodity dollars or "Comdolls" for short.
These three currencies are among the major currency pairs, which mean they have great liquidity and volatility for active trading.
How do commodities affect commodity currencies?
Raw materials compose such a large portion of these countries exports, a rise in commodity prices can possibly lead to a rise in the value of a country's currency, and vice versa.
Let's take a look at the major commodity currencies and see how much their movement correlates to certain commodities...
Canadian Dollar (CAD) and Oil
Oil is the life blood of the industrialized world and thus a highly watched and traded commodity. While oil is often nicknamed "Black Gold", we prefer to call it "Black Crack".
Many countries that produce "black crack" and hold massive reserves of "black crack" tend to benefit from rises in oil prices, including Canada. We like to call these countries the Black Crack Mafia.
Canada is one of the world's largest producers of oil (black crack dealers) and holds oil reserves (black crack stash) second only to Saudi Arabia, which makes Canada very reliant on its most prized commodity. It is also the largest supplier to the world's biggest oil consumer (black crack addict) - the United States. Because oil is such a big part of the US economy, rising oil prices tend to have a negative affect on U.S. equities and the U.S. Dollar.
Wait a minute! Rising oil prices tend to be good for Canada/bad for the U.S., while falling oil prices tend to be bad for Canada/good for the U.S. - how can we play this idea in the Forex markets? Anyone? USD/CAD??? Right! In fact let's take a quick look at a chart overlaying oil prices and the USD/CAD:
As you can see from the chart above, price movements USD/CAD and Oil are inversely correlated from each other - meaning as oil trends higher, USD/CAD tends to trend lower and vice versa.
Since January 1988, USD/CAD and Oil have had about a 68% inverse correlation to each other. This is a pretty strong correlation. As a currency trader, knowing this can add another tool to your toolbox when analyzing USD/CAD and help you make longer term trading decisions.
Australian Dollar (AUD) and Gold
Everyone loves gold - how can you not love it? It's metal, shiny and makes pretty cool jewelry. Besides that, gold is used in many, many applications like highly conductive wiring, reflective coating, and dentistry - you should check out Big Pippin's new grill!
In the financial world, gold is viewed as a safe haven against inflation and it is one of the most highly traded commodities. Okay, so how does all of this tie into Forex trading? Great question! To answer that, we'll take a look at the Australian Dollar.
For many traders out there, trading the Australian Dollar is just like trading gold. Australia is one of the world's largest producers of gold and it exports comprise over 50% of commodities, including precious metals.
These commodities account for a large portion of Australia's Gross Domestic Product; so many traders watch the rise and fall of commodity prices, especially gold, which can influence the direction of the Australian Dollar. Let's take a look at a comparison chart of gold and the "Aussie:"
This is a monthly chart that compares the price movement of gold and the AUD/USD all the way back to January 1980. As you can see, the two's movements were virtually the same, and from January 1980 to about January 2002 one can view gold as a leading indicator to AUD/USD.
The "red stars" above show major turning points in gold. These turning points seemed to occur before major turning points in AUD/USD. This relationship changed around 2002 as gold and AUD/USD movements were practically the same until gold shot up in value in 2005 to 2006.
Just as we learned with oil and USD/CAD, traders can watch gold prices to get an extra edge in their analysis of AUD/USD as gold movements can give possible clues to where AUD/USD is headed. For those who can't trade gold directly, AUD/USD's strong correlation to gold makes a great substitution. You can trade AUD/USD in the spot Forex market as a proxy for gold, which is traded in the futures market.
New Zealand Dollar (NZD)
Much like its neighbor to the west, Australia, New Zealand's economy is also export-driven with commodities comprising much of its exports. While most traders' view on the "Kiwi" is that it's not directly linked to one specific commodity, its correlation to commodities in general is a substantial one.
Since January 1990, its correlation is 63%, when compared to the Commodity Research Bureau Index (CRB Index), one of the world's standards for commodity prices.
This chart shows how commodity prices and the New Zealand Dollar have moved in tandem with each other over the past 25+ years.
Since January 1990, the NZD/USD and CRB Index has had approximately 60% correlation. So, as commodity prices rise and fall, traders can look for similar movements in the NZD/USD because of New Zealand's dependency on its commodity exports.
Like gold and oil, a trader can express their general views and ideas on commodities by trading NZD/USD.
Summary of Commodity Currencies
We have just learned about relationships between commodities and commodity currencies. There are a few things to remember before you start applying the ideas learned here today.
Short term moves in commodities usually do not directly affect a commodity currency immediately. Analyzing commodities for use with currencies is probably best suited for longer term outlooks, trading, and investing.
Keep in mind that even though we see strong correlations between the commodity currencies and commodities, exports are only a portion of a country's economy. Always take a look a country's overall economy, interest rates, and political situation as well.
Combining all of these aspects and adding commodity movements in the mix can present a clearer picture and possibly better trading ideas in these currencies.
So, for those of you into Oil, Gold, and commodities in general, check out the "ComDolls." With the leverage and liquidity advantages available in spot Forex trading, currencies can be an awesome alternative to trading straight forward commodities or for hedging your commodity investments! Don't be scurrrrreedd...Check'em out!