Friday, September 05, 2008
Time and again you hear things like, "In commodity markets today, a stronger dollar pushed oil and gold lower...", and everyone seems to accept that relationship as if it were somehow a law of nature. As if it were causation rather than correlation.
But, does it make any sense?
The commonly heard explanation is that commodities such as crude oil and gold are denominated in dollars on commodity exchanges around the world, so when the dollar strengthens against other paper money, these commodities become more expensive in terms of other paper money, making them less appealing.
But does this even make any sense?
While it may be true over a period of hours or days, over weeks or months, it is certainly not true. For example, if you bought an ounce of gold on August 1st using euros, this would have cost you 590 euros, since gold sold at about $915 per ounce and one euro could be exchanged for $1.55.
At the moment, that same ounce of gold would cost just 560 euros ($800 per ounce with the euro at $1.42) meaning that since the time that European traders sold gold because it was getting too expensive, it has actually become five percent cheaper.
Looked at another way using the PowerShares US Dollar Index ETF (UUP) along with the iPath Crude Oil ETN (OIL) and the SPDR Gold Shares ETF (GLD) in the chart below, in the last seven weeks, the trade weighted dollar has gained about eight percent versus other freely traded currencies while the price of oil and gold have fallen more than double that amount.
A one-to-one relationship might make sense, but to say that the dollar rose by x percent and, as a result, oil and gold fell by 2x or 3x percent doesn't make sense.
The idea that the dollar is strengthening against the euro, the pound, and other currencies because their economies now look to be getting much weaker, much faster than the U.S. economy which will result in lower demand for commodities makes a lot of sense, though only the brighter reporters in the mainstream financial media seem to make this connection with near the regularity of the dollar up/commodities down meme.
But even this argument works only when economies, in general, are weakening.
If, for example, the global economy was booming and growth in the U.S. surged, this would cause the dollar to rise against other currencies, but would this be a signal for commodity prices to be pushed lower?
Perhaps someone could enlighten me on the relationship between the dollar and commodity prices which, in the past, I've referred to as nothing more than a "Pavlovian" response by traders which, incidentally, didn't work out so well in 2005 when both the dollar and commodity prices rose.
Importantly, note that 2005 was the only year of the last six when the dollar rose.