Understanding commodity currencies

One of the most exciting aspects of forex trading is realising how dependent and correlated some markets are to each other. The case of commodity currencies and pairs is a perfect example of such correlation. 

Going back to our school years, many of us were left intrigued when we first heard about the ‘butterfly effect’. According to the chaos theory, a tiny change in initial conditions can create a significantly different outcome. Notably, in the butterfly effect illustrative example, the formation of a tornado can be influenced by a distant butterfly flapping its wings several weeks before. 

With the butterfly effect in mind, you can start to understand why, for instance, the Australian dollar has remained weighed down over the past weeks on the potential collapse of Evergrande, China’s most prominent property developer.  

So, it’s no surprise that there are strong correlations between different products and events in trading, just like certain currencies are linked to the global prices of primary commodity products. 

Countries with large commodity reserves are heavily dependent on the export of raw materials for their GDP. So, such economies are sensitive to changes in commodity prices. 

The dependency of specific currencies on commodities is what makes them a ‘commodity currency’. 

The 3 top traded commodity currencies

The currencies with the closest commodity correlations are the Canadian dollar (CAD), the New Zealand dollar (NZD)  and the Australian dollar (AUD). Paired to the US dollar, these are called ‘commodity pairs’ and are among the most widely traded currency pairs. 

Australian Dollar (AUD)

The AUD currency is also known as the ‘Aussie’. Australia is one of the most resource-rich nations on the planet. As a result, Australia’s currency is heavily dependent on commodity prices, as it exports coal, iron ore, petroleum and gold.

Australia’s economy is tied with China’s economy. China is the global manufacturing and industrial growth giant and therefore depends on Australia’s primary commodities. 

Canadian Dollar (CAD)

The CAD currency is also known as the ‘Loonie’. Canada is the fifth-largest oil producer globally; therefore, the price of oil is a significant driver in the Canadian economy’s health. 

Canada’s economy is tied with the US economy, with approximately 75% of Canadian exports going to the States.

New Zealand Dollar (NZD)

New Zealand has a solid connection to gold and will react to movements in the commodity’s price. Also, New Zealand is the globe’s biggest exporter of milk products and exports other farm products such as meat and wool. 

Like the Australian dollar, the New Zealand dollar (also known as the ‘kiwi’) is affected by China. This is because China imports vast quantities of dairy products from New Zealand; therefore, kiwi’s value is linked to the volume of dairy products exports.

Other currencies with commodity price correlations include the Russian ruble (RUB), the Brazilian real (BRL) and the Saudi riyal (SAR). 

Why and how to trade commodity currencies

So, why do commodity-linked currencies attract traders? 

The nature of the commodity currencies allows forex traders to move in and out of trades quickly. Moreover, commodity currency traders can take advantage of the commodity price fluctuations. 

Some of the price movers of the commodity currencies include macro and monetary policy events and decisions. In fact, any event that can impact a commodity’s price can affect commodity currencies as well. For example, OPEC meetings, market sentiment, central bank policies and political tensions list factors affecting commodities and commodity currencies.   

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