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- Broad commodity prices have been falling since the middle of summer 2022.
- We find certain currencies, such as NOK and CAD, are most correlated to commodities, in particular with Brent Crude.
- The correlations suggest commodity investors could hedge downside commodity price risk, including lower oil prices, by being short CME Group NOK/USD or CAD/USD futures.
Exports increasingly important to currency considerations
Exports of goods and services are becoming increasingly important. They account for over a quarter of global GDP, having comprised just 10% in 1970. For some nations, exports are concentrated on a few commodities. For example, Australia sees 45% of its export’s income come directly through the trade of iron ore and coal. Countries such as Australia, and consequently their currencies, prosper when the value of commodities rise.
In contrast, countries with a trade deficit typically struggle when commodity prices rise because they must pay more for their imports. As a result, their currency depreciates so their exports can, in turn, become more attractive to foreign partners.
Commodities considerable driver of FX price action over past year
Accordingly, last year’s commodity price strength was a big challenge for nations with a trade deficit. CME Group Commodity Index spent portions of the year having returned +50% since 1 January while never closing the day lower than it started the year. Russia’s invasion of Ukraine meant energy commodities experienced the strongest rally; Brent Crude at one stage surpassed 60% returns for the year while Natural Gas reached triple-digit appreciation. Unsurprisingly, in these periods, AUD and NOK saw the largest appreciations against the USD in G10 (Chart 1).
However, CME Group Commodity Index has been falling since June 2022. That means the currencies that previously outperformed have come under fire as commodity prices returned to a more sustainable level. Meanwhile, currencies such as CHF and EUR have recovered.
Hedging commodities with FX
Both scenarios demonstrate why it can be effective for investors to consider underlying FX relationships when investing in commodities. Had an investor believed Brent Crude would appreciate past June 2022 to date, they would have lost 36%. However, had that same investor been long CME Group Brent Crude futures and long CME Group CHF/USD futures, the loss would have been around 26%.
Using the CME Group Cross-Asset Correlation Tool, we find that NOK and CAD are most correlated to Brent Crude; GBP and SEK are most correlated to copper; NZD and JPY are most correlated to gold (Chart 2).
This suggests investors who are positioned for Brent Crude prices to rise again could hedge by being short CME Group NOK/USD or CAD/USD futures. They could do likewise for CME Group GBP/USD and SEK/USD futures for copper, and CME Group NZD/USD and JPY/USD futures for gold.
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