How commodity prices can affect the forex market

Although the forex market is based solely on the relative value of different currency pairs, commodity prices can have a significant impact, either boosting or undercutting certain currencies in relation to others. Strongly performing commodities Commodities Commodities are assets that are either naturally grown or occurring in the environment. Most commonly this includes precious metals such as gold, silver, and palladium.Beyond metals, commodities can also focus on agricultural or industrial goods that are central to manufacturing or other sectors. This includes crude oil, copper, wheat, and others.Relative to other assets, commodities are an extremely complex form of investment, with many similarities and differences to existing products.Commodit Commodities are assets that are either naturally grown or occurring in the environment. Most commonly this includes precious metals such as gold, silver, and palladium.Beyond metals, commodities can also focus on agricultural or industrial goods that are central to manufacturing or other sectors. This includes crude oil, copper, wheat, and others.Relative to other assets, commodities are an extremely complex form of investment, with many similarities and differences to existing products.Commodit Read this Term, such as gold or oil, may be a mainstay of national economies and so have a knock-on effect on the value of the national currency. When that currency is paired with another that is also affected by the same commodity, but in the opposite direction, the correlation can be exploited to profitable effect.

Significant correlations

As an example, one might look at Canada, which is a major exporter of oil, and Japan, which imports most of the oil it needs to sustain its economy. The value of the Canadian dollar is correlated with the price of oil, so that when oil is in demand, the Canadian dollar is correspondingly worth more. But in such circumstances, Japan must pay more for its oil, which means the economy may struggle, causing the yen to dip.

Potential profits

It's not hard to see how a canny trader, watching the price of oil, could exploit a significant shift in either direction to profit on the forex market by buying and selling CAD/JPY pairs. In another example, Australia is one of the world’s biggest gold producers, while the US is one of the biggest buyers. The value of gold can affect both the US and Australian dollar, meaning AUD/USD pairs can theoretically be traded in relation to gold prices.

Multiple markets

Of course, there’s no reason why traders should be restricted to only forex or only commodities. If they are confident about the price movement of the commodity, and the correlation with the currencies in question, they could potentially make a greater profit by trading in both. A simple gold trading guide can help forex traders become adept in buying and selling this much-coveted commodity as well.

Sudden shifts

Traders hoping to exploit the correlation between currency and commodity should exercise due caution. The relationship can shift suddenly. Both positive and negative correlations can sometimes be stronger and sometimes weaker or negligible. They may even occasionally reverse.

Timing is everything

Before entering into a trade, the correlation must be fully understood and monitored, using historical data to inform any decision. The trade itself should be carefully timed so as to be executed with minimum risk and hopefully maximum profit. Correlations can sometimes happen for a short period and then diverge.

Indirect correlations

Although correlations between commodities and currencies generally happen when a country is dependent on natural resources, either its own or from elsewhere, the correlation can be less direct. For instance, although the economy of New Zealand is agriculture-based, its main trading partner is Australia. As we’ve already seen, the Australian economy is closely tied to the price of gold. This means that there is a similar, if indirect, correlation between gold and the New Zealand dollar.

A bit of research can reveal many correlations between commodities and currencies, but traders should be absolutely sure of their facts before acting. Nevertheless, fluctuations in the forex market that might otherwise seem random can be easily understood if commodities and their impact are correctly understood.