Forex Fundamentals
Learn

What Is a Commodity Currency?

By Rutger Lokin · Updated

What is a commodity currency? It is the currency of a country that sells so much of a raw material abroad that the price of that material shows up in its exchange rate. Among the majors that means the Australian, Canadian and New Zealand dollars. The Norwegian krone is the fourth in the G10.

That gives you a driver that sits outside the country’s own calendar. The Canadian dollar can have a bad week with no bad Canadian news at all, because oil had one.

Follow the export money

Think of a country as a business. When the price of what it sells rises against the price of what it buys, it earns more for the same shipments. Economists call that ratio the terms of trade.

That extra income does not stay abroad. Exporters convert it to pay wages, suppliers and taxes at home, company earnings and government revenue rise, and the economy runs a little hotter. A hotter economy lets the central bank keep rates higher for longer. For a currency trader that last step matters most, because rates are what the currency is priced on.

Which commodity goes with which currency

Get the match right before anything else. Oil tells you little about the New Zealand dollar, and dairy tells you nothing about the krone.

Late 2014: what an oil crash does

Brent crude averaged $111.80 a barrel in June 2014 and $47.76 in January 2015 (EIA data on FRED). Over the same months the US dollar went from 1.08 to 1.21 Canadian dollars (FRED) and from 6.04 to 7.69 krone (FRED). The Canadian dollar lost about a tenth of its value against the US dollar, the krone about a fifth.

Then the central banks followed. On 11 December 2014 Norges Bank cut its rate to 1.25 percent and said the sharp fall in oil prices was likely to soften the petroleum industry further (Norges Bank). On 21 January 2015 the Bank of Canada cut to 3/4 per cent, “in response to the recent sharp drop in oil prices” (Bank of Canada).

Notice the order. Both currencies had been falling for months before either bank moved, because traders start pricing the cuts as soon as the income outlook turns. And Norges Bank wrote that the weaker krone was helping to dampen the blow to the economy. A falling commodity currency is part of how the country absorbs the shock.

They fall in a scare

Demand for raw materials rises and falls with world growth. So these currencies tend to be firm when the world economy feels fine and soft when fear takes over, the mirror image of a safe haven currency.

March 2020 shows how hard that can hit. The Australian dollar bought 66.5 US cents on 9 March and 57.6 cents on 23 March (FRED), a fall of more than 13 percent in two weeks with no Australian news behind it.

Rates are where it lands

Because the commodity reaches the currency mainly through rate expectations, keep the rate gap in view. Compare these currencies with the rest on Interest rate differential by currency pair, and with inflation taken off each side on Real interest rates by currency. The decisions to mark are the RBA Interest Rate Decision, the Bank of Canada Rate Decision and the RBNZ Interest Rate Decision.

Where the link misleads

Newcomers expect the currency to follow the commodity tick by tick. It won’t. The link runs through income, over weeks and months, and on any given day rate news or the risk mood can swamp it.

Even month by month the link is loose. From 2010 to 2019 the Canadian dollar moved the same way as oil in about 7 months out of 10, and the correlation between their monthly changes was 0.59, where 1 would mean they moved in lockstep and 0 not together at all. The krone’s was 0.55. Since 2020 both have been closer to 0.4.

The Australian dollar tracked iron ore no more closely than it tracked oil: about 0.3 with each in the 2010s, and 0.35 with each since 2020. Part of what they share is probably not their own commodity at all but world growth and the US dollar, which can push raw material prices and these currencies at the same time. These are monthly averages of the Fed’s H.10 rates and the IMF’s prices for crude oil and iron ore, from 2010 because until then most iron ore was sold at a price set once a year. Each currency’s own story is in its guide, linked above.

They also forget to ask why the commodity is moving. Oil rising because the world is growing helps the Canadian dollar twice, through income and through risk appetite. Oil rising on a supply shock in a slowdown gives you a much muddier picture.

And they treat the krone like the loonie. Norway pays the state’s oil and gas revenue into its oil fund, which invests only abroad, and spends roughly the fund’s expected real return of about 3 percent a year (NBIM). The fund was set up to cushion the economy against swings in oil revenue, and it does: most of the state’s oil money stays invested abroad instead of being spent at home in krone.