Commodity currencies explained

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By :  ,  Financial Analyst

Commodity currency definition

A commodity currency is a currency that moves in a correlated step with the global price of primary commodities due to certain countries’ dependency on the export of raw materials for income.

The commodities include minerals like copper, iron ore and coal, energy products such as oil and gas, precious metals, and dairy products like milk.

Commodity currencies are prevalent in countries like Australia, New Zealand, Brazil, South Africa, and Russia because their economic performance is tied to commodity exports.  

The top three and most traded currencies with the closest commodity correlations are the Canadian dollar, the Australian dollar, and the New Zealand dollar.

The Japanese yen is also considered a commodity currency. It reacts to oil price because Japan relies heavily on imported oil to match its domestic nuclear power capability.

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Let’s look at three currencies – the Australian (AUD), New Zealand (NZD) and Canadian dollars (CAD) – and consider the factors that make them commodity currencies and what commodity-related issues and events can move their price.

Australian dollar

Australia’s extensive natural resources make it one of the most resource-rich nations on the planet. It’s the globe’s most prolific coal and iron ore exporter and exports enormous quantities of gold and petroleum. As a result, commodity prices directly impact the value of the Aussie dollar versus its peers.

Because it’s the globe’s top producer and exporter of coal and iron ore, the sector’s income is highly susceptible to currency price changes.

Perhaps the main reason Australia’s currency is so closely aligned to commodities is the country’s link to China, arguably the powerhouse of global manufacturing and industrial growth.

Australia’s economic dependence on China is significant. China is Australia’s largest trading partner, accounting for 32.6% of its exports in 2019.

Australia’s mines deliver iron ore, coal, and gas to fuel China’s growth. Australia is preferred to rivals such as Brazil due to the quality of the Aussie minerals and the close geographic proximity.

The price Australian miners can charge for iron ore and other minerals are directly linked to China’s economic performance. If China experiences a blip or slump in economic activity and growth, its demand for raw materials and minerals will drop. As a result, Australian producers will suffer, and the value of AUD will most likely fall.

Alternatively, Australian exports provide direct insights into China’s economic performance. If China demands more raw materials and refined products from Australia, investors and traders conclude that China’s economy is expanding. The increase in demand for Aussie products will typically lead to a rise in the value of the Australian dollar.

The price of gold can also positively correlate with the Australian dollar value, especially the AUD/USD currency pair. Australia is a net exporter of gold, so when the price of gold appreciates, AUD/USD tends to rise. If gold slumps, then the price of AUD/USD can follow.

Canadian dollar

The value of the Canadian dollar versus the US dollar (USD/CAD) is strongly correlated with commodity prices, especially oil. Canada is the fifth-largest oil producer globally, and oil accounts for ten per cent of the nation’s exports.

Canada’s close geographical and cultural proximity to the US means the two economies are inextricably linked; seventy-five per cent of Canada’s 2019-2020 exports went to the United States. All oil produced and refined to other by-products gets exported to the United States.

Canada has vast natural resources and commodities, such as timber and energy and the Canadian economy is heavily reliant on their production and sale. Because oil and fuel combined are the largest exports, the oil price has a massive impact on Canada’s overall financial health and stability.

The correlation between the Canadian dollar and oil prices is primarily due to crude oil being the nation’s most significant foreign exchange contributor. When oil prices rise, the Canadian dollar typically follows due to its reliance on its export markets.

New Zealand dollar

New Zealand (NZ) is the globe’s biggest exporter of milk products and exports other farm products such as meat and wool.

Like the Australian dollar, the New Zealand dollar’s value is affected by China and the Asian continent’s economic performance and subsequent demand.

Both China and Australia import vast quantities of dairy products from NZ; therefore, the value of NZD is directly linked to the volume of dairy products it exports.

New Zealand often has a higher central bank interest rate than other countries, so investors convert funds to the NZD currency to obtain a higher yield. This practice is known as a carry trade, using a low-interest yield currency to buy a higher-yielding currency.

Other currencies with commodity price correlations

  • Russia has the third-largest oil reserves on planet earth and is number one for gas reserves, and the ruble’s value fluctuates with the price of crude. Most of its energy exports go to Europe and Asia, and the ruble can fluctuate in wide ranges as the price of oil moves
  • Norway is the globe’s fifteenth largest oil producer, so the Norwegian krone reacts to the oil price
  • Venezuela’s bolivar has collapsed in conjunction with its oil production.
  • Saudi Arabia’s riyal will move in line with oil and gas prices
  • Brazil, Mexico, Peru, and Chile mine and produce coal, gold, copper, and other minerals, impacting their domestic currencies value

Most forex traders will not trade minor and exotic currency pairs involving krone, bolivar and ruble. The spreads are too broad, and the trading volume is too thin and unpredictable.

Instead, FX traders looking to trade commodity currency pairs typically concentrate on USD (US dollar) pairs like AUD/USD, NZD/USD, and USD/CAD.

What moves the value of commodity currencies?

Any calendar event likely to affect a commodity’s price will impact a commodity currency’s value. Here are a few of the most prominent events and data releases worth diarising involving oil, gold, dairy products, iron ore and other minerals.

OPEC meetings

The Organisation of the Petroleum Exporting Countries (OPEC) is an intergovernmental organisation of 13 countries headquartered in Vienna, Austria. The member countries account for an estimated 44 per cent of global oil production and 81.5 per cent of the globe’s estimated oil reserves.

The organisation meets twice a year at its Vienna headquarters; in late spring and late Autumn. Oil ministers agree on production quotas for members, but discussions usually start weeks or months before the official meeting.

The decisions taken at OPEC meetings or decisions released during the year by the organisation will affect the oil price measured in dollars and, consequently, all other commodity currencies.

Once the official communique is published, or if their intentions are leaked during the meetings, the oil price can change rapidly.

The price of oil can also fluctuate in wide ranges before, during and after the meetings, so forex traders who specialise in commodity currency pairs should think about modifying their strategies to accommodate any decisions—perhaps adjusting stops or taking some profit off the table.

United States oil inventory, consumption and stockpile data

As the largest consumer of fossil fuels on the planet, the inventory, stockpiling, and usage data from the US can impact the value of WTI (West Texas Intermediary) oil specifically. If domestic usage increases and stockpiles reduce, the price of WTI might rise and take commodity currency pairs with it.

Investors and speculators in oil also keep an eye on the number of rigs in use or erected, information that is customarily released each Friday afternoon in the Baker Hughes report. Some analysts suggest a break-even and worthwhile investment point for new rigs of $50 a barrel.

The Middle East and African political tensions

According to OPEC data from 2020, the Middle East is responsible for 42% of global oil production. With 10% of the known international reserves of oil and gas, African nations also have a crucial role in the smooth distribution of supply. If this is interrupted through conflict, the price of oil and its value versus USD can change.

Market sentiment

Overall market sentiment can also impact the value of commodity currencies. Precious metals are seen as safe havens, as are certain currencies such as the Swiss franc, Japanese yen, and the US dollar.

If the value of gold rises in dollar terms because investors globally are nervous and seeking out safe havens, commodity currencies can also increase in demand. However, negative sentiment can drag the value of other commodities like oil down which might suppress specific commodity currency pairs.

China’s GDP and other data

China is second to the US for global oil consumption, 14 million barrels a day and 20 per cent of total consumption according to the BP statistical report on world energy use published in 2020.

The economic performance of China can alter the price of oil on global markets. Various Chinese metrics can affect the oil price, such as GDP, industrial output, and export and import figures.

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Related tags: CAD AUD Forex Insights Commodities

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