A fundamental factor of the world commodities markets that many investors fail to appreciate is that, in most cases, the assets are priced and traded in U.S. dollars. This relationship is one of the key reasons that commodity prices have broadly weakened in recent weeks as the U.S. dollar has strengthened on the heels of increasing hype about trade wars and other geopolitical factors. In this article, we take a look at several charts suggesting that the sell-off in commodities could be overblown and that strategic traders may actually be looking to buy given the lucrative risk-to-reward setups. (For a quick refresher, check out: Commodity Prices and Currency Movements.)
With the accessibility of foreign exchange markets, it is now possible for retail investors to gain exposure to the U.S. dollar paired against pretty much any of the world's most popular currencies. As most experienced traders will attest, movements of currency pairs are hinged to country-specific economic announcements, while measuring against a broader basket can remove some of the volatility. With the rise in popularity of exchange-traded products such as the Invesco DB US Dollar Index Bullish Fund (UUP), investors can track the performance of the U.S. dollar relative to a basket of six major world currencies – the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
Taking a look at the chart, you’ll notice that the price of the fund has moved higher since April, and the recent increase in momentum has investors gossiping about a long-term move higher. With that said, notice how the price is now trading near the combined resistance of two trendlines and its 200-week moving average. These long-term levels of resistance suggest that the momentum could run out of steam here and that a pullback could be in the cards over the coming weeks. Based on the sentiment in the market, a pullback in the value of the U.S. dollar would likely take many investors by surprise and would likely correspond to a sharp move and an accompanying spike in commodities. (For more on this topic, check out: How to Trade Currency and Commodity Correlations.)
As discussed above, the rise in the value of the U.S. dollar over the past several months has corresponded with a significant move lower among a broad basket of commodities. The inverse relationship between the U.S. dollar and commodities is clearly evident by the movement of the Invesco DB Commodity Index Tracking Fund (DBC), which you can see has drifted toward the support of two key trendlines and its 200-day moving average. Active traders will likely be looking to buy into the exchange-traded fund near the support at around $17 to make the most of the lucrative risk-to-reward setup. (For further reading, see: 3 Charts Suggest Commodities Uptrend Is Just Getting Started.)
Gold is one of the major commodities that has trended lower during the recent rise in the U.S. dollar. Taking a look at the weekly chart of the SPDR Gold Shares (GLD), you'll notice that the fund has recently found support at the 200-week moving average like it has done in the past, and the two nearby trendlines are also acting as levels of support that would trigger a significant bounce back toward the resistance of the upper trendline near $129. Stop-loss orders will likely be placed below $117.75 in case the dollar continues to find strength or there is another type of sudden shift in underlying fundamentals.
The Bottom Line
The prices of world commodities have suffered in recent weeks due to the strength of the world's reserve currency – the U.S. dollar. The inverse relationship is well known and is commonly traded by long-term traders. While most retail investors are discussing the chances that the greenback continues to climb, technical traders are looking to the charts, which are suggesting that a pullback for the dollar could be in the cards. In the event that this thesis comes to fruition and the U.S. dollar does dip, it could mean a short-term rise for those invested in commodities. (For more, see: 3 Charts That Suggest It;s Time to Buy Commodities.)
Charts courtesy of StockCharts.com. At the time of writing, Casey Murphy did not own a position in any of the securities mentioned.