Correlations between the world's most heavily traded commodities and currency pairs are common. For example, the Canadian dollar (CAD) is correlated to oil prices due to exporting, while Japan is susceptible to oil prices because it imports most of its oil. Similarly, Australia (AUD) and New Zealand (NZD) have a close relationship to gold prices and oil prices. 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. 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.
Deciding Which Currency and Commodity Relationships to Trade
Not all currency/commodity correlations are worth trading. Traders need to take into account commissions and , 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.
Canada is a major exporter of oil, and thus its economy is affected by the price of oil and the amount it can export. Japan is a major importer of oil, and thus the price of oil and the amount it must import affects the Japanese economy. Because of the major effect oil has on Canada and Japan, the CAD/JPY positively correlates with oil prices. This pair can be monitored as well as the USD/CAD. The downside is that the CAD/JPY generally has a higher spread and is less liquid than the USD/CAD. Since oil is priced in U.S. dollars throughout most of the world, the fluctuating dollar impacts oil prices (and vice versa). Therefore the USD/CAD can also be watched given that the two countries are major oil importers and exporters.
|Figure 1: CAD/JPY versus adjusted oil prices. Chart shows weekly data for 2007
|Source: TD Ameritrade
Figure 1 shows that there are times when the currency pair and oil diverged. The oil prices are adjusted. Figure 2 uses unadjusted oil prices and, through 2010, a strong correlation can be seen showing it is important to monitor correlation in real-time with actual trade data.
|Figure 2: CAD/JPY versus unadjusted oil futures (percentage terms). YTD (2010), daily.
|Source: TD Ameritrade.
Australia is one of the major gold producers in the world. 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. This means that New Zealand is also highly affected by Australia's relation to gold. In 2008, Australia was the fourth-largest gold producer in the world. In 2009, the U.S. was the third-largest buyer of gold. Therefore, the AUD/USD and NZD/USD are suitable for trading in relation to gold prices.
|Figure 3: AUD/USD versus adjusted gold futures (percentage). Chart shows weekly data for 2007 through 2010.
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.
|Figure 4: AUD/USD versus unadjusted oil futures (percentage). YTD (2010), Daily.
Currency commodity relationships may change over time. 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.
Deciding Which Instrument to Trade In
Upon knowing which currencies and commodities have strong relationships, traders need to decide which tradable currency pair they will make their trades in, or if they will trade in the commodity and currency. This will depend on several factors including fees and the trader's ability to access a given market. The charts show that the commodity is often the more volatile of the instruments.
If accessible, a trader may be able to trade the commodity
and currency pair from one account due to the widespread use of commodity contracts for difference (CFDs). (See for more on this topic)
Monitoring the Correlation for "Cracks"
It is also crucial to point out that just because a relationships exists "on average" over time, does not mean that strong correlations exists at all times. 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.
A commodity and currency pair that is highly positively correlated one year, may diverge and become negatively correlated in the next. Traders who venture into correlation trading should be aware of when a correlation is strong and when it is shifting.
The panic hasn't even started!
As ordinary citizens with no power over the levers of policy, we watch from the sidelines, and weep. The whole global economy has tipped into a downward spiral. Trade and output are contracting at rates that outstrip the leisurely depression of the 1930s. Debt deflation has simply washed over the drastic measures taken by governments everywhere.
Judging by the latest Merrill Lynch survey of fund managers, investors have a touching faith that China is going to rescue us all and re-ignite the commodity boom
Get ready for higher long term interest rates
Higher U.S. interest rates will be due to:
1. Higher inflation; cheaper dollar. T-buyers are demanding a higher
interest rate to compensate for inflation and the falling dollar.This
inflation is caused by higher world commodity prices and is outside
control by the Fed Reserve.
2. Foreign sovereign funds are pulling out of U.S. Treasuries. The
Chinese economics minister and OPEC spokesman and others have already
announced this pull back Foreigners, who own more than half of our $9.5