Commodity Currencies to Include in Your Portfolio

If you’ve been trading a while, you’ve probably come to realise that some currencies track primary commodity goods. These are the domestic currencies of nations abundant in specific natural resources and export them in the form of raw materials for income.

A 2009 study on these currencies Can Exchange Rates Forecast Commodity Prices? by Chen, Rogoff and Rossi, has established that exchange rates of commodity currencies can be used to forecast global commodity prices. This is a reliable source of information for economists and researchers who are concerned with commodity valuation; a tricky subject in a domestic economy. It is also beneficial for investors to diversify their portfolios.

Recently, Goldman Sachs and other bodies like The World Gold Council (WGC) published reports favouring investments in gold and other commodities on account of surging commodity indices in 2019, citing that investors would continue to invest in them as a hedge against systemic risk.

Some currencies are more closely tied to commodity movements than others.

1.     The Australian Dollar (AUD)

Australia is the primary global exporter and producer of iron-ore, a prominent raw material in several industries; particularly steel. In fact, 98% of the globally mined iron-ore is used to manufacture steel. The ore is also used for train tracks and other infrastructure, construction and engineering purposes, which is why the demand for iron-ore is extensive in emerging economies like Brazil and China.

Mining activities in iron-ore and gold have secured continuous economic growth for Australia, fueled particularly by the rapid urbanisation and consumerism in cities like Perth. Other commodities that share a positive correlation with the Australian dollar are high-grade copper, aluminium, wheat, wool, beef and coal.

Due to its isolated location, Australia needs to import large amounts of various goods that are not produced within the country. It is the 20^th largest goods importer in the world. This can create problems in the balance of trade, which can have an impact on the domestic currency. As demand for iron-ore weakens from a slow-moving Chinese economy, the Australian dollar could also depreciate in tandem.

2.     The Canadian Dollar (CAD)

The 10^th largest economy in the world in terms of nominal GDP, Canada has the fourth highest estimate of natural resources, valued at US$33.2 trillion in 2016. It is also the fourth largest exporter of petroleum and natural gas. The Canadian dollar tends to have a positive correlation with lumber, wheat, soybeans and corn prices.

Crude oil extraction and mining are among the biggest contributors to the country’s foreign exchange reserves and GDP, which means rising and falling oil prices reflect on the movement of the CAD. The lumber industry in the nation has stabilised after years of activism, to adopt more sustainable models. It is important to keep track of such events, since the CAD is heavily connected to lumber trading.

3.     The Russian Ruble (RUB)

Russia contains over 30% of the global natural resources, valued by the World Bank at US$75 trillion, as of 2016. It is a prominent exporter of oil, natural gas and precious metals. In addition, the Russian ruble has a positive correlation with lumber prices. The timber reserves of Siberia and the Russian Far East are the largest in the world, along with the mineral backed Ural Mountains.

It is one of the largest producers and exporters of gold and diamond. Oil and gas were consistently the source of hard currency for the country, being Russia’s number one export. However, in 2018, the RUB decoupled from Brent Crude, following US sanctions. Experts suggest that as global warming melts arctic ice consistently, several vast areas will become more accessible. These areas reportedly contain large untapped reserves of oil and natural gas.

4.     The Colombian Peso (COP)

Petroleum comprises 45% of Colombia’s exports, and commodities occupy a significant portion of its exports. It has the largest coal reserves in Latin America and holds the second position after Brazil in hydroelectric power generation. Other major exports include cacao beans, rice, coffee and emeralds.

With the rapid fall of the Venezuelan economy, Colombia is now one of the biggest oil exporters to the US, which is the world’s largest consumer of oil.

5.     The New Zealand Dollar (NZD)

The New Zealand dollar is the 10^th most traded currency in the world. The country’s economy is highly agriculture based. It is a huge exporter of dairy products, fruit, wine, meat and seafood. Australia is the largest bilateral trading partner for New Zealand, followed by China and the United States. Naturally, the NZD has a close correlation with domestic currencies of these countries, which form high consumer bases for products like beef, milk and pine logs.

Factors That Affect Commodity Currencies

Some factors that affect the prices of commodity currencies include:

1. Price of Commodities: Fluctuations in the underlying commodity prices affect these currencies. If a commodity is performing very well, then there is great demand for the associated currency, raising its value.
2. Economic Indicators: Country-specific economic indicators, such as interest rates, inflation and consumer purchase index, impact domestic currencies. During rising commodity prices, economies of the commodity-producing nations also flourish, which leads to higher domestic interest rates. Investors will sell low-yielding currencies in exchange for high-yielding ones, in what is known as carry trade. These carry trades drive commodity currency prices. Australia and New Zealand are both prominent places for carry trade activities.
3. Trade Terms with Other Countries: The demand and supply equation of commodities also affects currency prices. If the economy of a significant trade partner country is in decline, the demand for commodity exports will reduce too. This affects commodity currencies.
4. Inverse Relationship Between USD and Commodity Prices: The US dollar is the benchmark pricing mechanism for most commodities, particularly oil. It is also the exchange mechanism in most international trade contracts for raw materials. When the value of the USD declines, it becomes expensive to buy commodities. Traders should keep a close eye on the price quotes of the dollar index, to study the USD and its correlation with commodity prices.

Reference Links

• https://academic.oup.com/qje/article-abstract/125/3/1145/1903653?redirectedFrom=PDF
• https://www.forbes.com/sites/greatspeculations/2019/01/14/gold-and-commodities-set-to-soar-in-2019/#757af3cc63ed
• https://www.forbes.com/sites/greatspeculations/2018/09/05/5-world-currencies-that-are-closely-tied-to-commodities/#30a55a381685
• https://www.cmegroup.com/education/featured-reports/hedging-portfolio-with-commodity-currencies.html
• https://en.wikipedia.org/wiki/Economy_of_Canada
• https://www.investopedia.com/university/forex-currencies/currencies8.asp
• https://en.wikipedia.org/wiki/Economy_of_Colombia
• https://www.thebalance.com/how-the-dollar-impacts-commodity-prices-809294