Commodity Pairs: What They Are and How to Invest

Most Forex traders tend to focus on the most important currencies, which are the euro, dollar, pound, yen, and therefore invest in a limited number of pairs, if not exclusively in the euro-dollar pair. Yet, the Forex market is full of opportunities even if you look elsewhere, at currencies that often struggle to break out of the niche of experts. Among these are the so-called commodity currencies, which in turn give rise to commodity pairs. The term commodity currency refers to a currency whose value is strongly correlated to one or more specific commodities. The term commodity pairs, on the other hand, refers to pairs formed by one of these currencies and the dollar. The main commodity currencies are the Canadian dollar, the Australian dollar, and the New Zealand dollar. Consequently, the commodity pairs are USD/CAD, AUD/USD, NZD/USD. What is the link between currency and commodity? Simple: some economies, specifically the Canadian, Australian, and New Zealand economies, are essentially based on the production and export of commodities. Now, all countries export, to a greater or lesser extent, goods of this type, but only the countries just referred to depend on such activity. The dependence is so strong that it generates a heavy impact on the currency market. Commodity pairs should be considered for one particular reason: they are easily readable, and they are so because the price trend of commodities is easily readable. Before illustrating the pairs one by one, it is good to offer some general guidelines, a sort of instructions for use. Their influence is felt mainly in the long term. This is true because most commodities are characterized by very long trends. Volatility is obviously present, although to a lesser extent than other pairs, stocks, and bonds, but often the market tends to ignore them and focus on long-term movements. Commodities are important but not decisive. Okay, it is established that some commodities significantly influence the value of some currencies. However, it is not the only factor at play. In fact, it is also necessary to look at the other half of the moon, which in the case of commodity pairs is the dollar. Those who trade with this type of "pair", therefore, must refer to all the "American-driven" market movers and pay special attention to the monetary policy of the Federal Reserve. Consider indices useful only for very long-term trading. Indices group general commodities, without distinguishing between the various raw materials. It takes some time before the entire sector can move in unison and thus act as a market mover. Consider the geopolitical situation. Both Canada, Australia, and New Zealand are very stable countries. The problem, from a geopolitical point of view, does not concern them but the large exporting countries. If one of these countries is in the throes of chaos, demand risks being reduced. Now that we have framed the phenomenon, it is possible to examine the commodity pairs one by one.

The Canadian dollar, i.e. USD/CAD

Canada is one of the largest oil exporting countries in circulation. You wouldn't think so, since oil is generally associated mostly with the Middle East, and yet Canada exports oil everywhere, especially to the United States. The credit goes to the presence, widespread in Canadian territory, of oil sands, which are sedimentary rocks from which bitumen is obtained, a raw material for synthesizing crude oil. In light of what has been said so far, the value of the Canadian dollar depends heavily on the price of oil. If this increases, the CAD appreciates. Consequently, the pair drops in value (it's obvious, since the first term of the exchange is the dollar). It is therefore a matter of studying the market movers of oil and trading accordingly. One of the main market movers related to oil are the crude oil stocks held by the United States which, perhaps a bit paradoxically, are among the large producers and among the few countries to make their stocks public. However, it is clear: if U.S. production undergoes changes, this has effects on the supply of the material as a whole, thus affecting the price. Obviously, even if it does not represent a structural market mover, OPEC meetings are to be studied, which can decide - as has actually happened recently - to favor a cut in production or an increase, depending on needs. At the moment, oil is trying to recover after years of contraction and lows not seen for many years. OPEC, therefore, has been forced to impose a production cut urbi et orbi. Another market mover, perhaps the most important among those related to oil, is represented by the demand of importing countries, in particular - in this case - the United States. It is obvious, if demand is skewed in favor of supply, prices fall. To understand how demand is behaving, various parameters can be used: GDP, industrial production, manufacturing PMI. Demand is an important element because oil, in addition to being the fuel for means of transport, is the fuel to make machinery work. Finally, the geopolitical situation. If this heats up in correspondence with strong oil-producing countries, the price of oil rises and, consequently, the NZD/USD pair.

The Australian dollar, i.e. AUD/USD

Different story for Australia. Its main business, in fact, is the extraction and sale of gold. This, then, is the element that influences the value of the Australian dollar and therefore the relative commodity pair. It should not be forgotten, in fact, that gold is also a commodity. Deciphering the behavior of the price of gold and predicting its near future is therefore essential for trading the AUD/USD exchange rate. Now, what does the price of gold depend on? Answering is both easy and difficult at the same time. Easy because the market movers of the yellow metal are well defined and almost always illuminating. Difficult because, after all, it is much more volatile than other commodities. These market movers, let's be clear, have little to do with demand from other countries, if it concerns economic activities. It is mostly a matter of investments. Gold is a safe-haven asset and as such is the object of interest from investors (more than usual) when... Things are going badly. If traditional investments do not yield or are characterized by strong instability, gold is often used to preserve capital. This occurs in most cases when three events occur. First: currencies undergo a devaluation, which often generates a domino effect, i.e., the classic currency war. The exchange risk, in this case, becomes really high. Second, monetary policies are ultra-expansive and lower the yields of all investments with a domino effect. Actually, in this second case, the alternatives are numerous (e.g. investment in emerging markets) but gold also benefits greatly from it. Finally, when mass investment products, such as stocks, experience a difficult moment. In fact, the classic stock market panic is followed by an increase in the price of gold. From this point of view, it may be useful to look at the various indices, which summarize the state of health of the various sectors in a fairly faithful manner. On the other hand, gold loses value if monetary policies embark on a restrictive, non-accommodating path, precisely because it is more convenient to invest in financial products and interest rates are higher. Even when stock markets perform well, gold tends to fall. Lately, gold has been suffering in the face of the growth of new assets, which are characterized by an unusual growth rate and are aiming straight for safe-haven asset status. Think, for example, of Bitcoin. Let's be clear, the value of Bitcoin should not yet be considered a market mover of gold, as the phenomenon is only in its infancy, but in the future this correlation could crystallize. Finally, a small note, whose principles have been illustrated in the previous paragraph but which is worth remembering. These market movers have a negative correlation with the AUD/USD pair. When market movers push gold upward, the pair goes down. When market movers push gold downward, the pair goes up. This happens because, as mentioned, the first term of the pair is the USD.

The New Zealand dollar, i.e. NZD/USD

Much more complex are the mechanics of the New Zealand dollar. This is for two reasons. First, the New Zealand dollar is, among commodity currencies, the least traded of all, so liquidity is reduced and so is volatility. Secondly, unlike the Canadian dollar and the Australian dollar, it does not depend largely on a single commodity which, as we have seen, is oil in the first case and gold in the second case. New Zealand's economy, in fact, is clearly driven by commodity production and exports, but not by a single commodity. There are more than a couple: gold, timber, agricultural products above all. Now, we have talked extensively about the market movers of gold. So all that remains is to deal with timber and agricultural products. Well, the market movers of timber and agricultural products are really few, at least the structural ones. Reference can be made, however, to the parameters that illustrate the performance of the primary sector. Of course, one can and must refer above all to the demand of importing countries. New Zealand's major trading partners are, in this order: China, Australia, European Union, Japan. So, keep an eye on the data that reveal the state of demand in these countries: industrial production, manufacturing PMI, even consumption. Let's close with a general piece of advice. Commodity pairs are clearly oriented by commodity prices, this is true. However, it is impossible to even think about investing simply by studying commodities, as if they were the only factors at play. The currency market is complex, also because it mirrors an economic-financial system characterized by interdependence. The best way, therefore, is to produce technical and fundamental analysis as if you were trading with "normal" pairs. Only, it is necessary to give more space and dedicate more time precisely to the commodities which, we repeat, are: oil for Canada, gold for Australia, gold and agricultural products (and timber) for New Zealand.