Again there is a hue and cry in the market that dollar index has noticed terrific movements, for this reason this is the perfect time to sell commodities. We take it as a thumb rule, if USDX is moving up then go short in commodities. Does this thumb rule work always???
Let’s find out the myths and facts …
The USDX is a trade-weighted basket of the US dollar versus other major currencies. Sometimes the volatility in dollar index can be attributed to the major movements in other currencies or what is happening in the other currencies economy apart from other factors. For example; USDX has seen around 23% rise in just over 4 months. It was the biggest move the USDX has ever made over such a short span in this index’s entire history! This mindboggling progress was not due to the strength of USD but simply because of the weakness of other major currencies amid some improvement in US data’s. At the same time, commodities could not see steep fall in the prices due to seasonality. It happens many times. Yes, I agree that dollar index give impact on the prices, sooner or later, but as a secondary driver not as primary.
Return Of Various Commodities And Dollar Index From 2000-2010(In %age)Click to enlarge
Above chart is revealing the secondary nature of the dollar’s role in commodities prices. During the secular bull run between 2000 to 2010, commodities gave mindboggling performance. It gained between the wide ranges of 64% to 410%. On the contrary, dollar index lost around 23%. It is showing that supply and demand far outweighed the dollar…
Why the entire world track dollar index while trading in commodities or have physiological impact of dollar index on commodity???
What I believe that it is in fact very complicated to synthesize fundamentals into tradable whole as in many commodities credibility of data is questionable and come on wide intervals. Various other factors which give impact on the prices are not easily reachable to all traders. Moreover, we are familiar with the fact that commodities fundamentals develop gradually and cannot change overnight and thus it is unable to give massive moves in a short span of time. Many times it is sentiment over and above news driven.
Here dollar index gain importance, as transaction of many commodities are done in terms of USD worldwide, hence any fluctuation in USD give significant impact on the commodity prices. Moreover, the dollar’s levels are always available in real-time and consequently it is uncomplicated watching the movements of USD to game commodities rather than exploring into their fundamentals. However, we cannot deny that in a particular time period dollar index becomes the primary driver of commodity.Movements Of Dollar Index And CRB (2000-2010)
Click to enlarge
Above graph is showing negative correlation between USDX and CRB but percentage of volatility is more in CRB. Even in 2009, CRB recovered by whopping 20% whereas dollar index only fell by 5%.
As on whole USDX has proportionately negative correlation with commodities but it is not the main driver. Nevertheless, sometime relationship between dollar index and commodities are positive. For example; in the time period of December 1998 to September 2000 relationship between crude oil and USDX was positive for such a long period. Many times commodities and USDX move in similar direction in perception of the health of the global economy. Fear and uncertainty surrounding the global economy stimulate safe haven buying in both.
Concluding with the view that each commodity has its own fundamentals, demand and supply profile, which drive its prices. Though, the secondary driver, dollar index often give impact on the commodity prices significantly. Hence, it is advisable that take it as a significant indicator, but rely on seasonality and own fundamentals of commodity before the investment of your money.
Disclosure: No Position