US Dollar and Global Commodities

Anand James, Commodity Analyst, Geojit

(Global commodities as used in this passage refer to those commodities like Gold, Silver, Crude Oil, Natural Gas, Copper, Zinc, Aluminium, Tin, Lead, Nickel, etc. which are actively traded in Commodity Exchanges world wide and are mostly dollar denominated.)
By mid Mar 2008 the U.S. dollar had plunged to record low against a basket of major global currencies like, Euro, Yen etc. on persistent worries about global financial turmoil and U.S. recession concerns and the following series of Fed cuts, taking interest rates to 2.25% from plus 5% rates prevailing prior September 2007.
Impact on the United States
• By lowering rates, US Fed may have helped US Companies’ effective cost of capital, encouraging them to make more capital expenditure, which could help the valuation the stocks in the long run.
• Being a major Oil consuming and importing nation, surging oil and gasoline prices fuelled by the weak green back may add to inflationary pressures in the US.
• The US Dollar is fast losing its lustre as a reserve currency. While some central banks are diversifying their forex reserves in favor of the Euro, OPEC’s second-largest producer Iran has asked for payments in Euro and Yen, rather than dollars.
• Imports become more expensive. At the same time, U.S. exports become relatively cheaper, which could boost domestic production, thus reducing the trade deficit.
• Expansion, Mergers & Acquisitions would appear cheaper to foreign firms looking to expand in the United States. However, on the other hand, the weak dollar raises the take over prices for US firms looking to expand overseas.
US Dollar And Global Commodities
The US Dollar’s sharp depreciation had triggered major bull runs in Oil, Precious metals, and some Base metals as well, more so during the last one year, after a series of emergency measures from the Fed and following firmness in Dollar paused the rally in those commodities. This has once again put into sharp focus, the inverse correlation between the greenback and commodity prices.

However, the strength of the correlation between the Dollar and commodities varies. The quasi monetary role played by Gold makes it strongly correlated to Dollar’s price moves. In the case of base metals, a weak dollar reduces non US producer’s profits, creating a negative supply effect while also reducing prices for non US consumers creating a positive demand effect. While the afore mentioned factors are also applicable for energy commodities like Crude Oil, especially as it is mostly dollar denominated, geo political tension also come into play. In the case of agricultural commodities, the correlation is still lower as seasonal factors are more in focus.
On closer scrutiny, we can see that the rise in prices, especially that of commodities is more of a function of the money used for exchange (the US Dollar here), and that such fiat currencies are fast losing their purchasing power. For eg: even though both Crude and Gold fell 6 to 7% towards the end of March 2008 in Dollar terms, the quantity of gold required to purchase a barrel of Crude has hardly changed. To illustrate the impact of currency further, one can compare the peaks of MCX Gold and London Spot Gold in 2006 and 2008. After touching a high of $730 per ounce in 2006 London Spot Gold dipped and then rallied again to touch $1030.8 per ounce in March 2008. Corresponding figures for MCX Gold are Rs. 10763/10g and Rs.13397/10g. It is worthwhile to note here that even though London Spot and MCX Gold are highly correlated, from 2006 to 2008, London Spot appreciated 41.2%, while MCX Gold’s rise was at a modest 24.4%. The villain of the piece here was Indian Rupee, which appreciated 9.4% against US Dollar during this period. It will be interesting to note here that, had INR remained constant during this period, the peak of MCX Gold last month would have been 15197/10g instead of the actual 13397/10g, which is sizeable difference and cannot be satisfactorily explained by demand-supply fundamentals.
On a closing note, here is a quote from Henry Thornton, Governor of the Bank of England (from his book “An Enquiry into the Paper Credit of Great Britain, written in 1802)
“We assume that the currency which is in all our hands is fixed, and that the price of bullion moves; whereas in truth, it is the currency of each nation that moves, and it is bullion which is the more fixed.”