I recently spoke at an ETF conference about commodities. During the panel discussion I mentioned that commodities includes a lesser known factor; currencies. An investor may view commodities partially as a currency play.
Many commodities are quoted in U.S. dollars (spot $DXY). In the short-term the direction of $DXY may not impact commodities (S&P GSCI spot), however, over the longer-term a trending $DXY may impact commodities. For example, if the dollar is moving higher, commodities become more expensive to the rest of the world. Thus potentially reducing demand and potentially having an impact to suppress commodity prices. If the dollar weakens, commodities become cheaper around the world relative to other currencies. This could increase demand for commodities and potentially increase prices.
The Long-term correlation of the $DXY to S&P GSCI is -0.3. However when analyzing the rolling 12-month correlation of the dollar to commodities we find the correlation has a maximum and minimum of 0.64 and -0.92 respectively. Over time the rolling 12-month correlation has gradually become more negatively correlated.
Chart1: 12 Month Rolling Correlation of $DXY to S&P GSCI. March 1985 to June 2016
To eliminate some of the noise of a short-term correlation, I also examined the 36-month rolling correlation of $DXY to S&P GSCI (Chart 2) and found a stronger trend for a negative correlation. This would be when longer-term trends occur in both the dollar and commodities. With a maximum of 0.16 and a minimum rolling correlation of -0.76. Since 2008, the 36-month rolling correlation has sustained a strong negative correlation, ranging from -0.76 to -0.54. Implying when the $DXY becomes directional, there is an increased probability for the S&P GSCI to do the opposite.
Chart 2: 36-Month Rolling Correlation $DXY to SP GSCI
In Chart 3, the NAV of the S&P GSCI and $DXY illustrate how the markets have trended in opposite directions at various moments. Chart 3 initially invests $100 in both indices. Although the benchmarks have the same starting NAV, the $USD was more mean reverting versus the S&P GSCI. Therefore using the same axis makes it difficult to see how $DXY traded. Utilizing the right axis for the $DXY is easier to see how it moved over time.
The black circles in Chart 3 denote major moments when the markets diverged from each other. Including the recent few years. There are also some moments when they are moving in the same direction, but the extended moments is what really matters.
Chart 3: NAV of DXY and S&P GSCI
Chart 4 offers a good illustration of rolling returns of the indices moving in opposing directions over time based on a 36-month rolling return of $DXY and S&P GSCI
Chart 4: 36-Month Rolling Return of USD and SP GSCI
In summary, there is a general tendency for the U.S. dollar to have a negative correlation to commodities. It won't happen all the time, and in fact there will be times they may move in the same direction. But as a macro theme, if many commodities are quoted in dollars and the $DXY appears expensive to the rest of the world then demand for commodities could decrease or at least commodity users may seek substitutes that are quoted in other currencies. As the dollar increases or at least sustains its price, it could at least become more difficult for commodities as a sector to rally over the longer-term and could be building a bottoming base. However, individual commodity markets may find reasons to rally based on their specific characteristics and fundamentals regardless of $DXY.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.