Predicting the next move in the markets is the key to making money in trading, but putting this simple concept into action is much harder than it sounds. Currencies are moved by many factors - supply and demand, politics, interest rates, economic growth etc. Since economic growth and exports are directly related to a country's domestic industry, it is natural for some currencies to be heavily correlated with commodity prices. A hidden string ties together currencies and crude oil, with price actions in one venue forcing a sympathetic or opposing reaction in the other.
This correlation persists for many reasons including resource distribution and market psychology. And crude’s significant contribution to inflation and deflation intensifies these interrelationships during strongly trending periods, both higher and lower. In addition, crude oil is quoted in US Dollars so that each uptick and downtick generates immediate realignment between the greenback and numerous forex crosses. These movements are less affected in nations without significant crude oil reserves, like Japan, and more correlated in nations that have significant reserves, like Canada and Russia.
In general, there is no uniform rule for determining what commodities a given currency will be correlated with and how strong that correlation will be. However, some currencies provide good examples of commodity-forex relationships. Considering that the Canadian dollar is positively correlated to the price of oil, therefore as the price of oil goes up the Canadian dollar tends to appreciate against other major currencies. This is due to the fact that Canada is a net oil exporter; when oil prices are high Canada tends to reap greater revenues from its oil exports, giving the Canadian dollar a boost on the foreign exchange market.
Crude oil shows tight correlation with many currency pairs for three reasons. First, the contract is quoted in U.S. dollars so that pricing changes have an immediate impact on related crosses. Second, high dependence on crude oil exports levers national economies to uptrends and downtrends in the energy markets. And third, collapsing crude oil prices have triggered sympathetic declines in industrial commodities, raising the threat of worldwide deflation that undermines economic growth, forcing currency pairs to reprice relationships.
If you want to trade commodity currencies, the best way to use commodity prices in your trading is to always keep one eye on movements in the oil or gold market and the other eye on the currency market to watch how quickly it responds. Due to the slightly delayed impact of these movements on the currency market, there is generally an opportunity to overlay a broader movement that is happening in the commodity market to that of the currency market. Bottom line: It never hurts to be more informed about commodity prices and how they drive currency movements.
