The Commodities Connection

The value of a currency and how it moves is related to events in the commodity
markets. Commodities are key resources in world growth, and they impact global
inflation. This chapter focuses on what the forex trader should know about the
commodity connection to currencies.
GOLD
Gold price movements are important for currency traders to understand. Gold acts in
many ways as a surrogate currency and a “safe haven” when money moves out of the
dollar in response to geopolitical crises. But gold is also a commodity on its own, adding
strength or weakness to currencies of countries that produce gold. South Africa, of
course, is the leading producer of gold, but its currency, the rand, is not floating, so
traders can look to the Australian dollar and the Canadian dollar for trading those currencies
when gold patterns provide trading opportunities.
Gold price action can also be a misleading guide to the currency trader. In recent
years, Gold has attracted a great deal of investment demand from exchange-traded funds
(ETFs). In 2003, ETFs were buying 20 tons of gold, and this rose to 500 tons in 2005. The
trader who looks at gold prices rising may interpret it as a reaction to the dollar, when
it actually can be reacting as a function of investment demand. Figure 5.1 shows gold
versus the U.S. Dollar Index (USDX).
Central banks have an important role regarding gold. They hold gold as part of their
reserves (see Figure 5.2). The world’s central banks have about 3.5 trillion dollars in reserves, and 15 percent is in gold. The key variable that can affect currency prices is
whether a central bank will increase its gold reserves and thereby decrease its reserves of
dollars or another currency. As a result, rumors of central banks increasing gold reserves
can disrupt currency prices.
The idea that gold is important to currency moves is sound, but needs to be qualified
and put in the context of world events. Sometimes gold acts as a store of value in times
of crises. But the correlations between gold moves and currency moves provide a great
deal of variation. The trader needs to be vigilant regarding what factors are moving gold.
At the end of the day, in the words of Phillip M. Hildebrand (member of the Governing



Board, Swiss National Bank), “the yellow metal continues to have a special significance
for central banks.”
COPPER
Copper is one of the world’s commodities that is strongly related to economic growth because
it is a key material for global infrastructure in the building and telecommunications
industry. For example, copper plays an important part in the industrial development of
China. As the world grows, more copper is in demand. The forex trader has to ask the
question: Who benefits from copper demand?
To answer this question, we should look at who produces copper. The world’s leading
producer of copper is Chile; however, the Chilean peso does not float. Australia is the
second largest producer of copper, and since its currency is freely floating, the Australian
dollar can be traded. The commodity connection with currencies is particularly strong
for the Australian dollar, the New Zealand dollar, and the Canadian dollar. A closer look
is presented in our section on currency personalities. Figure 5.3 shows the synchronicity
of the commodities to each other.


By ABE COFNAS