is commodity inflation, which, unlike an individual area or
country’s business activity, affects all economies. As inflation
rises and prices spiral upward, some people quickly start to
buy up future supplies of basic necessities as insurance against
higher prices in the future. In that scenario, prices go up not
because of healthy business activity but because of uncertainty
and fear—and fear moves markets. In that scenario the government
can increase the interest rate earned on cash deposits
to get individuals to sell off their stockpiles of supplies in
exchange for cash and the increased dividend created by
higher interest rates. This seems a responsible action but does
not work in all cases. Some individuals are inclined to hang
on to their supplies rather than take the cash, and attempts at
easing inflation can be thwarted.
Businesses and economies around the world wrestled with a
very similar fundamental problem with the supply of crude oil
from 2005 through 2008. Crude supplies were shrinking as
worldwide demand increased, and that caused the price of
crude to jump from under $40 per barrel in 2004 to a high of
$140 in July 2008. That created additional expenses and commodity
shortages and the fundamental complications that go
along with that situation. Those problems had not been in place
just a few years before. Countries that had their own supplies
of crude didn’t feel the need to raise interest rates, whereas
some countries and regions that did not have their own supplies
did. The interest rate differentials created opportunities for
traders but caused much confusion for the economists and
politicians charged with solving those complex problems.
Generally, a rise in commodity inflation will cause a rise in the
value of the currency of a country that has large supplies of that
commodity. Again, however, it is important to keep in mind that
currency valuations are relative. Many analysts and commentators
called the Canadian and Australian currencies commodity
currencies because those countries have an abundant supply of
commodities, and as the price of commodities moved higher
from 2002 through 2008, so did those two currencies. The
United States also has an abundance of commodities, whereas
Switzerland does not, yet the U.S. currency went down and the
Swiss currency increased sharply over that period. This leads to
the question, was there really a relationship between commodities
going up and these so-called commodity currencies going
up, or did they just happen to be different investment classes
that were going up at the same time? As it turned out, the
Canadian currency topped out a full seven months before crude
oil peaked, whereas gold peaked four months ahead of the
Australian dollar. As of December 2008, gold was off its all-time
high by just 15 percent and the Australian currency was off its
high by 30 percent.
We believe that both commodities and currencies are complex
vehicles that should be traded individually on the basis of
price movement. There are relationships between different markets
and asset classes, but relationships by definition change,
particularly when one is comparing complex pricing processes
such as commodities and currencies. “Don’t get caught trading
wheat in the corn pit” is an old Chicago trading adage. It can
be said that the same thing is true when one is trading a currency
that is based on a commodity’s price or vice versa.
Commodity inflation overall adds uncertainty to markets
as governments try to offset the effects of rising and falling
prices with interest rate or other policy changes when often
it is best to let the markets correct themselves. Uncertainty
in the markets produces price movement, which is always
beneficial for traders.
Source: Mastering the Currency Market: Forex Strategies for High and Low Volatility Markets
