As commodities in financial market has the same role as stock and currency, the ups and downs of commodity prices could significantly affect forex market.

commodity and forex

Nowadays, commodities like agricultural products and minerals are also being traded in the financial market. Like in the stock market, they too could be traded in spot, forward, futures, and various derivatives.

As commodities in the financial market have the same role as stock and currency, the ups and downs of commodity prices could significantly affect the forex market. Some commodities, such as Crude Oil and Gold are well-known as strong influences toward USD and other currencies.

Here is some basic idea of how they affected the market:

  • Crude oil: The rise and fall of crude oil will affect the currency of its exporters.
  • Gold: Gold is highly correlated to the US dollar.
  • Stocks: A good indication of the market sentiments.

This article will talk more about these assets affected the forex prices.

 

Crude Oil

Crude Oil is still one of the world's vital necessities today, despite the advances in renewable energy research. It is mostly mined through oil drilling. It is then processed into various kinds of fuel, like gasoline, kerosene, etc, and plastics and pharmaceuticals.

Like its fellow commodities, Crude Oil prices are determined by its supply and demand; or more specifically, the factors that influence its availability of it. Some of the most important are OPEC and natural disasters.

Some of the World's major crude oil producers banded together in 1960 within OPEC (Organization of the Petroleum Exporting Countries). It is an intergovernmental oil cartel comprising Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela.

Their decisions, be it a political one (such as an embargo), or in relation to oil production itself (production quotas and prices), have a definite influence on Crude Oil. War in and around these countries which was seen as endangering oil production, will drive up oil prices.

Oil prices, in turn, could influence currencies. International Energy Agency mentioned that high oil prices generally have a large negative impact on global economic growth.

Countries with high oil consumption will suffer from the high price, and in the long term, the burden will take shape in a deficit in their trade balance. That's why, a higher oil price will weaken USD, as the US is a major oil consumer.

On the other hand, countries that export oil like Canada and Norwegia will experience surges in their exchange rate.

 

Example

Suppose there is a sudden increase in crude oil prices due to geopolitical tensions or disruptions in crude oil production. As a result, countries heavily reliant on oil imports, such as Japan or the European Union, may experience increased import costs, leading to a trade imbalance and putting downward pressure on their currencies.

Conversely, countries that are major oil exporters, such as Canada or Russia, would likely benefit from higher oil prices. The increased revenue from oil exports strengthens their economies, potentially leading to an appreciation of their currencies.

For example, the chart below shows how the oil moves against the USD/CAD. That is because when the oil price rise, the CAD also rises. This causes the value also rises and causes the USD to fall against CAD.

CAD/USD dan oil

 

Gold

As an investment, gold has unique characteristics. Its long-term profit prospect has turned it into one of the few safe havens in the financial market. This is how it influences currency.

At good times, or when the world's economic prospect is good, investors will lose their gold and seek to invest in stocks and currencies. Conversely, erratic stock and currency markets will drive investors to seek safety in gold and increase the gold price.

Investors also use gold as a hedge against inflation, as it is the perfect anti-inflation instrument. Therefore, during a high inflation period, investors will seek gold and drive the price higher. Another party that may buy gold is the central banks.

Central Banks' buying of gold will affect the amount of money in circulation as they print more money in order to buy gold.  The result is a rising supply of a certain currency, which may push up inflation and influence the currency's exchange rate.

 

Example

Both gold and the US dollar are considered safe haven, particularly during times of economic uncertainty. Investors often flock to the US dollar when they seek safety, leading to its appreciation. During such periods, the demand for gold as a store of value may decrease, causing gold prices to decline.

The chart below shows that the price of gold moves opposite to the US dollar. When gold rises, the US dollar falls, and vice versa.

dollar vs gold

 

Stock Market

Theoretically, the stock market has no direct influence on the forex market. However, sometimes there are peculiarities in the movement of both markets, and analysts often found that certain stock market movements may give us clues into the potentials of certain currencies.

Jeremy Wagner of DailyFX noted that if the stock market moves upward, then AUD/USD, NZD/USD, and EUR/JPY tend to go up too. On the other hand, USD/CAD, EUR/AUD, and GBP/AUD tend to move downward. These are related to the risk carried by each currency pair.

Sean Hyman of Newsmax also described a similar phenomenon by observing year-to-year trends. As stocks boom from October to around May, He said, risk-on currencies like AUD, NZD, and CAD tend to perform the best. While the stock market decreases from May through October, currencies like USD and JPY will perform better.

 

Example

During the stock market crash, investors sought safer assets, resulting in increased demand for safe haven currencies like USD and JPY. The USD and JPY appreciated against other major currencies, causing currency pairs like EUR/USD, GBP/USD, AUD/USD to decline sharply.

In this chart below, when the stock market prices go down, the DXY is seen to arise. On the other hand, when the market upsurge, the US dollar is depreciated.

Dow vs dxy

 

Commodity prices have a lot of effect on the forex market. It is particularly correlated with the Australian Dollar. How does the commodity prices affect AUD?