Forex trading involves the purchase of one nation’s currency by using another nation’s currency. The price of a currency in relation to the other nation’s currency is called the exchange rate. Basically, it becomes a comparison of the macroeconomic and technical factors of the two countries involved that determines the exchange rate for that particular currency pair.

Commodity Prices

Commodity prices, on the other hand, are the prices of major global commodities being traded in the world markets. These commodities, just like currencies and stocks, have prices which are determined by market forces. And they fluctuate all throughout the trading day. Many factors like supply, demand, weather, production and stability affect commodity prices.

With those said, it may now be worthwhile to ask if commodity prices do affect currency exchange rates. At an initial glance, it seems that the two are totally independent from each other as those factors which determine commodity prices do not seem to affect currency exchange rates.

Correlation Between Commodities and Forex

But upon closer analysis, one can find some correlation between some commodities and a nation’s currency exchange rate. This is especially true if the commodity being observed is closely integral to a nation’s economy. Let us take nations with vast reserves of oil deposits as an example. These nations whose economies depend heavily on the oil trade would be greatly affected whenever the price of oil moves significantly. Whether favorably or unfavorably, whenever the price of oil moves, the economy of that nation would be affected as a major product of that country’s trade would be subjected to price changes. And when that nation’s economy is affected, the nation’s currency, where a nation’s economic health is usually reflected, would be valuated accordingly. Any sign of betterment for a nation’s economy as a result of a change in commodity prices for any of its major products usually translates into a rise in the currency’s exchange rate.

However, it should be noted that the degree to which a currency’s exchange rate is affected by movements in commodity prices would also be dependent on other factors. Thus, one may not expect that a rise in a country’s currency exchange rate will cut across the board for all other currencies it is exchanged with. It also depends on how correlated that nation’s currency is with a particular commodity. As an example, oil and gold are strongly correlated with the currencies of Canada, Australia and New Zealand. So, any rise in the price of oil, for example, would benefit the currency of these oil-rich countries as it would mean more money coming in for them.

Remember that in an exchange rate, there are always two sides to it – two nations with two different currencies, which are both affected by commodity prices in different degrees and manners. Thus, when analyzing how commodity prices affect forex rates, all these factors should always be taken into view. Correlation can always be studied based on price histories of different currencies and commodities.

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Tags: commodities, commodity prices, exchange rates, forex, world trade

Posted in Forex Education