Wikinvest Wire

The dollar and commodity prices: someone please explain

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.
IMAGE NAMEA 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.

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Anonymous said...

There is no point in deducing any relationship between any thing now. Each & every market has become extremely speculative and speculative unwinding is necessary & essential at the end of up run. Banks must be restricting credit to hedge funds and thus triggering massive sell offs in everything SELLABLE (gold or oil stocks) or TRADABLE to BEN BERNANKE (worthless mortgages).

Anonymous said...

Any guess on who our mystery guest will be for Bank Failure Friday.

I'll use the broken clock theory and go with WaMu

Funny Circus Bears said...

If you think this is contained to the US - think again.

Here is the best rant I've yet seen and it's based in the UK:

fish said...

"In commodity markets today, a stronger dollar pushed oil and gold lower..."

Perhaps someone would care to explain why the dollar would have strengthened today.....why it would have strengthened at all?

I'm Not POTUS said...

My head spins with the all the divergent issues.

Nish did not help me. It is going over my head.
see MISH today

Tim said...

Lance Lewis at Minyanville:

Very soon, the Treasury will be forced to nationalize Fannie (FNM) and Freddie (FRE), and the Fed will be easing even more (along with foreign central banks as well). It's well-nigh inevitable, and it will produce even more global inflation. Bank on it. Where the dollar goes vs. other fiat confetti is irrelevant.

The fact is that gold is rallying in all G7 confetti (see the charts below). And the reason gold is rallying in all currencies is because of just what Paul Volcker said today: THE FINANCIAL SYSTEM HAS "BROKEN DOWN." Default or debase... those are the only 2 options, and they both lead to the same place: More inflation and higher gold prices globally.

me said...

Silver State Bank, Henderson, Nevada, was closed today by the Nevada Financial Institutions Division, and the Federal Deposit Insurance Corporation (FDIC) was named Receiver.

Joe said...


I think you've chosen too short a time frame to see the correlation. If you look at longer time frames there is a high correlation between the value of the dollar and commodity prices:

NC Jim said...

If memory serves, in 2005 there was a special tax holiday for foreign earnings to be brought back to the US thus causing a demand for dollars. When the holiday ended at the beginning of 2006, the dollar decline resumed on fundamentals.

Please correct me if memory has failed.


Tim said...

I'm asking whether correlation is being confused with causation, not whether or not there is a correlation, which there certainly is.

Yes, I remember that now. But, you'd think that if traders simply looked at the dollar vs. other paper money they would have sold gold that year.

Joe said...


I have always believed that it is the currency that leads the commodities and there is a new study out that seems to confirm that:

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