Currency Traders: All Eyes on Commodities

Last updated 6/22/2009 9:36 AM EST (GMT -5) 2 Comments

Kathy Lien

Director of Currency Research, GFT

The Canadian, Australian, and New Zealand dollars are down sharply this morning as signs of a top emerge in the commodity markets. Oil prices closed below $70 a barrel on Friday and at the time of writing are trading at $67.90. Gold prices are also down $14 to less than $920 a ounce. On an otherwise quiet trading day in the FX markets that is devoid of any U.S. economic data, commodities are having a big impact on currencies.

On Friday, we showed the following chart of USD/CAD and oil. As you can see, the relationship is very strong with the correlation being close to 80 percent over the past 2 years.

Therefore the 2 percent drop in oil prices this morning, has driven the Canadian dollar sharply lower against the U.S. dollar and Japanese Yen, exacerbating the pessimistic tone that followed Friday's weak retail sales report. International Securities Transactions increased more than expected in April, but the uptick in foreign demand for Canadian dollar denominated assets has not helped the loonie. Although USD/CAD is flirting with the 1.15 level, the more interesting move is in CAD/JPY, which has broken significant technical support this morning. CAD/JPY is now trading below trend line support, the 50-day SMA and the 23.6% Fibonacci retracement of the year to date rally.

Is Dollar Driving Oil or Vice Versa?

Some traders may argue that oil prices are selling off because the dollar is higher. We have written about this at length last month in our special report Is Dollar Driving Oil or Vice Versa . The bottom line is that oil and the dollar have both a schizophrenic and symbiotic relationship.

Oil& nbsp; is priced in U.S. dollars. According to OPEC (the Organization of the Petroleum Exporting Countries), the relationship between oil& nbsp; prices and the dollar is almost mechanical. When the dollar falls in value, oil& nbsp; prices have to go up in dollar terms to stay constant in euro terms. Oil& nbsp; producers receive their oil revenues in U.S. dollars and need to be compensated for the fluctuations of the greenback. This does not always hold true of course but is valid over the long term.

Yet it can also be argued that rising crude prices is driving the U.S. dollar lower because it is putting a large burden on the global economy at a time when a recovery is within reach. A study by members of the IMF in 1996 found that a 10 percentage point rise in the real price of oil induces a 2 percentage real depreciation in a typical OECD country’s real exchange rate. Higher oil prices increases the cost of oil imports which in turn leads to a higher current account and trade deficit.

Oil at a Top?

The more important question for currency traders is whether oil prices have topped. From a dollar perspective, we expect the greenback to recover further this week after having become very oversold. There are also concerns that China will become less of a buyer in the second half of the year after having filled their coffers at low prices between January and May. We will be watching the Baltic Dry Goods Index for more evidence of this new trend. In the meantime, keep watching the commodities market for clues on where the Canadian, Australian and New Zealand dollars are headed next.

Comments (2)

KevinLiu

June 22, 2009 at 02:50 PM ET

Would lower oil prices help US Producer prices for month of July? Would the Iranian disorder negate the drop in oil prices?

klien

June 22, 2009 at 05:30 PM ET

If oil prices stay low and fall further, we could see PPI drop in July. We are a few weeks into the Iran disorder and the market has mostly priced in the effect

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.