Currencies markets in this new global economy are affected by a few factors, the most evident of which is the price of commodities. To most companies, it is very important to comprehend how the volatility experienced in commodity prices may affect the currency values, especially when their business deals with international trade.
This blog examines the way the fluctuations in the commodity markets can have a direct impact on the FX (foreign exchange) markets with emphasis on important factors including impact of commodity prices on the strength of currency, case studies, and adaptation strategies adopted by the traders to cope up with the changes.
The Impact of Commodity Prices on Currency Values.
Oil, gold and Machinery and equipment are some of the commodities that are important in the world economy. Exporters of these commodities generally experience an appreciation of national currency once the prices of these commodities go up. On the other hand, countries with imports of such commodities are adversely affected by an increase in price of the commodity as their currency becomes devalued since they now must use a larger amount of their local currency to buy such imported goods at a higher price in the market.
As an example, such nations as Canada and Australia (which rely heavily on the export of natural resources) are likely to experience appreciation of their currency in the cases when the cost of oil either goes up or up, or when the cost of another type of commodity increases. Conversely, the net importers of commodities, such as Japan or some European countries, are more likely to get the reverse effect. Commodity prices usually shift, causing their currencies to weaken.
Case Study: Oil Prices and the Canadian Dollars.
Perhaps, the most glaring of such a relationship is that of the Canadian Dollar (CAD) and world oil prices. Being one of the largest exporters of oil, the economy of Canada is considerably affected by the costs of crude oil. The Canadian Dollar is likely to go up when oil prices go up since the proceeds of oil sales become more substantial, which means the balance of trade goes up and the need of having CAD goes up.
As an example, when the price of oil increased significantly in the second half of the 2000s, the value of Canadian Dollar went up significantly against the US Dollar. This was attributed to the fact that the oil export revenues that were being earned surged the Canadian economy and boosted the demand of Canadian funds. In these situations of the falling oil prices like the 2014-2015 collapse in oil prices, the Canadian Dollar fell when the oil export volume fell and weakened the Canadian economy, the impact on the economic growth and the trading balances.
Linguistic Corrosion and the Geopolitical Issues and FX Effects on the UK.
The sensitivity of the UK to changes in commodity prices is also accentuated by geopolitical occurrence that may upset the world of commodity prices. The possibility of rising tensions in the main oil-producing countries, e.g. in the Middle East, or the straining of supply chains, e.g. by the COVID-19 pandemic, may cause unexpected commodity price shocks to sting the British economy.
Oil Price Shocks and FX volatility: Oil prices are volatile due to geopolitical events, such as war in oil producing nations resulting in a rise in the price of oil. Given that the UK is one of the net oil importers, this event may potentially lead to GBP depreciation with the increase of importation cost.
Brexit and Global Commodities: Brexit referendum and post-referendum had resulted in uncertainty in the global commodity markets too. Possibility of trade disturbances between the UK and the EU has brought about the movement of value of the GBP, particularly when commodities such as oil and agricultural products recorded the volatility in their prices because of the change of trade relation.
How Commodity Prices Influence FX Trading.
Forex traders are very sensitive to the economic indicators which affect commodity prices. By keeping tabs of the trends of the movement of oil, gold and agriculturally based products, the traders will be able to predict fluctuations in the value of currencies and move accordingly. The increase in commodity prices is usually characterized as an indicator of economic performance of any commodity exported country and a decrease in the commodity prices may indicate economic downturn and hence there is likelihood of the depreciation of the currency of that country.
The relationship has established a niche market where traders are specializing in the trade of money whose value is pegged to commodity such as the Canadian Dollar (CAD) Australian Dollar (AUD) and Norwegian Krone (NOK). As one of the critical pointers, these dealers take commodity pricing trends as an indication to anticipate the conjuncture of FX markets so that a deal can be made on whether to buy or sell currencies.
The fluctuations of the commodity prices impact greatly on the inflation here in the countries particularly those that are reliant to the importation of essential commodities. An increase in the price of commodities especially energy and food will lead to increase in cost of their production which will reflect to the people through increased prices. The management of commodity prices is a vital aspect of monetary policy since the central banks need to be keen on balancing between inflation and economic growth. Commodity prices and inflation are closely interconnected topics whose issues are central to any business as well as policymakers to pave way to better tackle the challenges of the economy whenever these two phenomena occur.
Ways to Mitigate this Risks
Here are several ways a person, whether a business owner, investor, or trader can navigate these challenges:
1.Portfolio Diversification of Business or Investment Diversification will also help to diffuse the risk and there will be less severity of moving up and down with a single commodity or currency. Companies can diversify so that they do not become reliant on any resource through expansion of their business into other corners or geographical markets. When the general portfolio is broader, the instability can be mitigated in case of any consequences.
2.The healthy knowledge of FX and commodity markets enables the businesses to make concerted choices. One can monitor the movements of the price by learning the market dynamics and trading online platforms. Education enables people to acquire knowledge to become successful in volatile markets.
3.Get Ready to commit in the Long Run Businesses that are involved in the risk of commodities and the FX need to plan both in the short run volatility as well as the long run stability. The long-term orientation also enables businesses to become very resilient to such market changes. Adaptability and flexibility are crucial to ride out the turbulences of the economy as the years go by.
4.Financial advisors can give individual recommendations on commodity and FX risks management. Good relationship with the corporate banks can provide accessibility to hedging services and market analytics. Professionals know how to make their way around all threats of currency markets and help them to establish a strategy to achieve good results.
Understanding the Link Between Commodity Prices and FX Market Movements.
Conclusively, the correlation that exists between the prices of commodities and the developments in the FX markets is a critical relationship especially to businesses that depend on international trade. Traders and owners of businesses can be in a better position to handle the dynamics of the international market by knowing how the changes in the prices of commodities can influence the currencies. Be it a commodity exporter such as Canada or a commodity importing country such as Japan, it goes without saying that it is imperative to identify these trends during decision making in the FX market.
In view of the ever changing dynamics in the global economic conditions, the correlation between the prices of commodities and the dynamic fluctuations of the currencies will be a ballpark necessity to any business involved in international trade. Keen observation of commodity prices will allow the business to predict the occurrence of fluctuations in the currency, protect their vulnerabilities, and utilise the opportunities associated with the dynamic nature of the FX marketplace.