The link between commodities and the US dollar

2023-09-01
Summary:

As the world's main reserve currency, changes in the value of the US dollar will directly affect commodity prices.

The us dollar index is a comprehensive indicator that reflects the exchange rate situation of the US dollar in the international foreign exchange market and is used to measure the degree of exchange rate changes of the US dollar against a basket of currencies. In the early days, the US dollar index was calculated based on the geometric average weighted value of the 10 major currencies' exchange rate changes against the US dollar in March 1973, and its value was measured against a 100-point benchmark. After the launch of the euro on January 1, 1999, the currencies used to calculate the US dollar index were adjusted from 10 to 6, and the euro also became the most important and weighted currency. At present, the euro has the highest weight in the US dollar index, at 57.6%; next is the Japanese yen, which is 13.6%; next, the pound is 11.9%; the Canadian dollar is 9.1%; the Swedish krona is 4.2%; and the Swiss franc is 3.6%. The analysis of the trend of the US dollar index can indirectly reflect changes in US export competitiveness and import costs.

Commodities and USD

There is a close relationship between commodities and the US dollar, and this relationship is interdependent.


As the world's main reserve and trading currency, the US dollar has a direct impact on commodities, as the pricing of commodities is usually based on the US dollar. Many commodities, such as oil, gold, copper, etc., are usually priced in US dollars, so changes in the value of the US dollar directly affect the prices of commodities. When the US dollar appreciates, the prices of commodities usually decrease because they become more expensive for holders of other currencies. On the contrary, if the US dollar depreciates, the prices of commodities usually rise because they become cheaper for holders of other currencies.


The supply-and-demand relationship of commodities will also affect the trend of the US dollar. The rise in commodity prices will increase production costs and inflationary pressures, which may lead to the central bank raising interest rates to curb inflation. Raising interest rates will increase the interest rate of the US dollar, making it more attractive and leading to its appreciation. On the contrary, a decline in commodity prices will reduce inflationary pressure, and the central bank may take interest rate-cutting measures, which may lead to a depreciation of the US dollar.


The strength of the US dollar will also affect global trade and economic activity, thereby affecting commodity demand. When the US dollar strengthens, the cost of importing commodities increases, which may lead to a decrease in demand. On the contrary, when the US dollar weakens, the cost of imported commodities decreases, which may stimulate an increase in demand. Therefore, the trend of the US dollar has a significant impact on the demand for and prices of commodities.


Based on the above analysis, it is generally believed that there is a negative correlation between the US dollar and commodity prices. When people worry about shrinking demand and sell their goods back to the US dollar, the increase in demand for the US dollar promotes its appreciation. When people actively use dollars to buy back goods, the increase in the supply of dollars increases the pressure of depreciation.

However, when analyzing the correlation between the US dollar index and commodities, it is also necessary to consider both the US economy and the global economy. In different macro-scenarios, it is not difficult to discover the following relationships based on specific historical scenario analysis:

The US economy is strong, the global economy is strong, and commodity prices are rising. At this time, the US dollar depends on the relative situation. If the US economy is stronger, the US dollar will rise, and the two are positively correlated. If the US economy is weaker than the global economy, the US dollar will decline, and the two are negatively correlated.


The US economy is strong, the global economy is weak, commodity prices are declining, and the US dollar is strong, with a negative correlation between the two. The US economy is weak, while the global economy is strong. Commodity prices are rising while the US dollar is weak, with a negative correlation between the two. The US economy is weak, the global economy is weak, commodity prices are declining, and the US dollar depends on its relative strength.

The link between commodities and the US dollar

US Dollar Commodities
Influencing Factors International Forex Market exchange rates, basket of currencies Priced predominantly in US dollars, supply-demand dynamics
Calculation Method Geometric weighted average, benchmarked at 100 points Prices typically denominated in US dollars
Currency Adjustments Reduced from 10 to 6 currencies Linked to fluctuations in the value of the US dollar
Central Bank Policy Impact Interest rate hikes and cuts Production costs and inflation pressures
Global Trade Impact Rise or fall in import costs Decreased or increased demand

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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