Investing Commodities – How to Use Commodities
Predicting price movements in the financial markets is a tough job. It is a tough job to new and experienced investors. This is because no one really knows what will happen to the dollar in the next 2 days. No one can accurately predict the movements in currencies, treasuries, and even stocks. In the past, we have seen very experienced investors make wrong trading bets. For instance, in the recent past we saw billionaire investor David Einhorn bet on a company called Sun Edison that went bankrupt a few months ago. We have also seen hundreds of sell-side analysts notes that have been wrong. For instance, a few months ago, Citi released a report which claimed that oil could go as low as $20 a barrel. It didn’t happen. Since it is not possible to make accurate predictions, investors and traders use analysis to predict the next moves in the market. In this article, I will highlight a few ways of using the commodity market to predict movements in the currencies market.
#1 – Safe Havens
The first way of using the commodity prices to trade currencies is to understand the value of certain commodities. For many years, many countries used gold as the main currency. In the United States, gold was fixed at a price of $35 per ounce before 1971 when president Richard Nixon removed the gold standard. This standard had been established in 1933 by Franklin Roosevelt. After the end of the gold standard, the price of gold started going up. Today, the inverse relationship between gold and the dollar remain evident. In many cases, when the price of gold moves up, the dollar on the other hand goes down. This is because investors move their cash to gold which is now regarded as a safe haven. A good example is what happened last week following the release of the non-farm payrolls which were below analysts’ estimates. When such a thing happens, a trader can either short the dollar or go long gold. However, it is always important to conduct correlation analysis before making these investment decisions.
#2 – Export and Import Driven countries
Countries in the developed world release their import and export numbers on a regular basis. This information can be found on the economic calendar. Traders should carefully assess these releases because they bring forward major movements in the market. For instance, Canada and Saudi Arabia are major oil exporters. If the price of oil keeps on going down, then the currencies in these countries will be under pressure. On the other hand, Japan is a net importer of oil. Therefore, if the oil prices head down, Japan will spend less Yen importing oil. This will lead to a stronger Yen. Therefore, as a trader, it is very important for you to correlate the price of commodities and use them to trade the respective currencies.
#3 – Dollar Denominated Currencies
Most commodities are usually denominated in dollar terms. For instance, oil prices are always stated in dollar terms. This is important because a stronger dollar will make a barrel of oil more expensive. For instance, in 2015, the dollar went up against major currencies. At the same time, oil was on a downward spiral. While oil prices were hampered by oversupply, the strong dollar also played an important role in depressing the prices.
#4 – Using Currencies as Supplements to Commodities
This is another important concept that can help you use currencies as supplements to commodities. This is however a more complicated strategy suited for seasoned traders. When you hold commodities such as oil, you earn no interest on them. However, if you hold a certain currency, it is possible for you to earn interest. For instance, if you placed a buy position on AUD/USD in 2009, it was possible for you to earn 3% interest if the rates in Australia remained at 3.25% while those of United States remained at 0.25%.