How are foreign exchange rates affected by commodity price fluctuations?

By Chris Gallant AAA
A:

In the foreign exchange (forex) market, currency valuations move up and down as a result of many factors, including interest rates, supply and demand, economic growth and political conditions. Generally speaking, the more dependent a country is on a primary domestic industry, the stronger the correlation between the national currency and the industry's commodity prices.

In general, there is no uniform rule for determining what commodities a given currency will be correlated with and how strong that correlation will be. However, some currencies provide good examples of commodity-forex relationships.

Consider that the Canadian dollar is positively correlated to the price of oil. Therefore, as the price of oil goes up, the Canadian dollar tends to appreciate against other major currencies. This is due to the fact that Canada is a net oil exporter; when oil prices are high, Canada tends to reap greater revenues from its oil exports, giving the Canadian dollar a boost on the foreign exchange market.

Another good example comes from the Australian dollar, which is positively correlated with gold. Because Australia is one of the world's biggest gold producers, its dollar tends to move in unison with price changes in gold bullion. Thus, when gold prices rise significantly, the Australian dollar will also be expected to appreciate against other major currencies.

To learn more, check out Commodities: The Portfolio Hedge and Commodity Prices And Currency Movements.

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