Higher commodity prices are generally good news for the likes of the Canadian dollar, Russian rouble and Australian dollar, but other factors – most notably central bank monetary policy – have weighed on the strength of these currencies during the past 12 months.
A number of commodity-linked currencies have a high correlation to crude oil in particular, and with the wider basket of commodities they track having been subdued during the past year, both AUD and CAD have remained relatively weak and to the bottom end of recent ranges.
During the period of weakening crude oil prices in the final quarter of 2018, the Australian and Canadian dollars both experienced double-digit falls.
Argentex FX dealer John Goldie observes that other commodities relevant to these currencies – such as the agricultural basket for AUD – have had varying degrees of volatility and therefore a less notable impact.
“Even the recent explosions in demand for iron ore and gold – of which Australia is a large producer – have had a lesser impact than crude oil, where the uptick in prices at the start of this year produced a bounce for CAD,” he says.
The commodities market is now concerned about a slowdown in China curbing demand for raw materials, while a decade of solid growth and low rates have left many commodity-producing companies with outsized levels of debt.
Worries about a reckoning in the bond market also mean producers are reluctant to commit to new projects, explains Adam Button, chief currency analyst at ForexLive.
“It is those commitments to spend billions of dollars developing new projects that spark major currency rallies,” he says.
However, the downturn in global growth data in the second half of last year and worries that this would hit metals prices also had an impact on the AUD, with the interlinked nature of global growth, metals prices and Reserve Bank of Australia policy making it hard to disentangle the currency from broader movements.
Currencies closely linked to commodities are often subject to wild swings and are handy barometers of risk appetite, notes Chris Beauchamp, chief market analyst at IG.
This is only part of the story, though.
“For CAD and AUD, it is often a story of broader risk appetite and the outlook for equity markets, given the health of the US dollar and the state of the global economy,” he says.
“Plus we have Fed policy to consider, which inevitably has a bearing on such currencies – a more hawkish Fed tends to lead to USD strength, although even here the relationship is not exact.”
Over the long term, currencies such as the Norwegian krone have generally experienced healthy relationships with the country’s major commodity, crude oil. However, BNY Mellon Markets senior currency strategist Neil Mellor points out that this has dropped off in most cases during the past year.
“A greater focus on yield explains some of this deviation, but it is far from a comprehensive answer and a year of political intrigue is undoubtedly a contributory factor,” he says.
In its performance against the USD, the CAD has traditionally held a close relationship with oil prices. Since 2010, the correlation comes in at 73%, versus NYMEX. However, during the past year this has dropped to just 25%.
“If we look at interest-rate differentials, the correlation between USD/CAD and respective US and Canadian 10-year yield spreads has been a rather impressive 93% since 2010,” adds Mellor.
“But, here too, the correlation has dropped to far lower levels since the start of last year, at just 40%.”
Even the RUB has seen a slide in correlation. The USD/RUB correlation with Brent oil prices is negligible during the past 12 months, but stands at 83% since 2010.
“For the Australian dollar, measured against the Thomson Reuters/Jefferies CRB index, there has been a fall-off in the long-term correlation with commodity prices from 72% since 2010 to 10% over the past year,” says Mellor.
ForexLive’s Button suggests that the relationship between commodity prices and currencies is poorly understood, referring to it as a series of thresholds rather than a linear relationship.
Taking oil in Canada as an example, he observes that at $70 to $80 there is new investment, which supercharges the Canadian dollar. From $50 to $70, there is an improvement in profitability, but the amount of new hiring and investment is moderate.
Below $50, there are production shut-ins – which start to become a serious drag on the currency – while below $35 there are solvency concerns, which trigger capital flight.
“Commodities are far from the only factor affecting commodity currencies,” says Button. “At the moment I would argue that there is more concern around the housing markets in Australia, New Zealand and Canada.”
In addition, central banks have been active, with the Bank of Canada hiking rates three times during 2018, adds Argentex’s Goldie.
“Recent policy decisions have been topical with commentators divided over whether the Bank of Canada is done hiking for now, while the Reserve Bank of Australia recently said that it could cut rates if spending slumps after it held firm at 1.5% earlier this month,” he concludes.