Can commodity values predict forex movements?

The Forex Files EP 8: Hard Evidence

The Forex Files EP 8: Hard Evidence

The Big Bling?

Not everything on planet Earth has been here since ‘the beginning’.

It’s been labeled as ‘otherworldly’ and the stuff of aliens or gods since humans first discovered it. It mesmerizes nearly all who possess it, and causes people to do all sorts of strange and sinister things to get hold of it.

There’s actually growing scientific consensus that gold did in fact arrive from outer space, during the ‘terminal bombardment’ of meteorites that hit our young planet 3.8 billion years ago.

Whatever the case, people have a knack for turning the Earth’s resources into some kind of profit. And that’s what we’re interested in here.

Anything that can be bought and sold is a commodity. But there are a handful that have such an impact on economies that they affect global exchange rates.

 

Natural gas tanks at night in Hong Kong, China.

The Black Cancer?

Oil infects nearly all segments of an economy – from the gas that goes into vehicles and electricity production, to manufacturing and the transport industry.

An increase in its price means that inflation will balloon in tandem.

The Asia Pacific region is one of the fastest-growing regions on the planet, and it needs a lot of oil in order to fuel that growth.

As many countries in the region are net importers of oil, a high price can quickly push inflation up and weaken national currencies here.

On the other hand, a drop in oil prices can push the currencies of net importers skywards.

This makes the net-importing oil countries of Japan, China, Hong Kong, Vietnam, Indonesia, The Philippines and Cambodia vulnerable when it comes to oil price fluctuations.

They can end up spending big amounts of their budget on subsidizing oil prices to keep them stable when global prices are high.

Since the year 2000, there have been two significant drops in global oil prices: the first in 2008 following the Global Financial Crisis, and again in 2014.

In both cases, the currencies of nations that heavily rely on oil exports were observed to drop.

The phenomenon can be clearly observed in the case of Malaysia, which is one of the few net exporters of oil in the Asia Pacific region.

 

From January 2014 to February 2015, crude oil prices dropped from US$110/br. to US$40/br. Consequently, the Malaysian Ringgit (MYR) experienced a drop from USD/MYR = 3.3 to USD/MYR = 3.6 during the same period.

But commodity prices don’t only affect exchange rates through inflation. Take gold, the alien metal that is one of the most highly traded commodities of a handful of Asian nations, including Hong Kong.

While Hong Kong is on paper a net exporter of gold, it doesn’t mine any on its territory. Instead, it imports high volumes of the precious metal and has it stored or processed into jewelry for later sale.

That accounts for how it was able to export around US$53.5 billion of the shiny stuff in 2016 alone.

But the chart above shows the relationship between the world gold price versus the Hong Kong Dollar.

In 2017, the world gold price increased from around US$1150/oz in January of that year, to US$1300/oz in Novevember 2017.

This was accompanied by a depreciation of the HK dollar from USD/HKD = 7.75 to USD/HKD 7.8 in the same period.

This depreciation gives a good indication of Hong Kong’s heavy consumption of gold imports.

As an importer, an increase in the price of a commodity is translated to higher import values, deteriorating the balance of payment and causing the currency to depreciate.

So, one of the mysteries of forex movements seems to have an underlying cause that while possibly having roots in some hidden corner of the universe, is in fact firmly determined by activities here on Earth.

A good idea for any investor holding forex is to keep track of what the main commodities being traded by that currency’s national economy are, and to be vigilant of any fluctuations.

Stay tuned to One Road Research for more resources on how to do just that.