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Mirror, Mirror: The Inverse Relationship Between Commodities and the US Dollar

10/09/2019

Lots of things can influence commodity prices. Weather may have an effect on the supply of crops. Inflation may force a producer to raise prices. And, as we saw in September when Saudi oil facilities were attacked—a jolt that triggered an immediate surge in oil prices—geopolitical events can also play a role. 


Yet one of the biggest factors that drive overall commodity prices is likely in your wallet right now: the US dollar. Simply put, the stronger the dollar, the weaker commodity prices. And vice versa. In fact, commodity prices and the dollar have an uncannily inverse relationship—mirror images of each other that even Superman and his look-alike nemesis Bizarro wouldn’t believe.


Take a look at the chart below. It compares the US Dollar Index (DXY) with the Bloomberg Commodity Index (BCOMTR), a common benchmark index for commodity performance. It starkly shows how strongly the price level of commodities and the strength of the US dollar mirror one another. Time and again, charts such as these illustrate that when the US dollar falls, commodity prices tend to rise, all else equal, with the reverse occurring in periods of dollar strength.


Figure 1

Sources: Bloomberg, Parametric, 12/31/2018. For illustrative purposes only. It is not possible to invest directly in an index. They are unmanaged and do not reflect the deduction of fees and expenses. Past performance is not indicative of future results. Please refer to the disclosures for important information.


What drives this inverse relationship? And are there exceptions at the individual commodity level? We dove into the numbers to find out. 


Why does a strong relationship exist between commodities and the US dollar?

It’s open to debate, but typically there are two arguments made to explain the dynamic between commodities and the US dollar:


  1. Real assets, such as commodities, have an intrinsic value, and when the US dollar fluctuates in its value, this intrinsic value is repriced in dollar terms. As the dollar rises in value, it takes fewer stronger dollars to purchase a commodity, and its price falls.

  2. The dollar-priced exports of American-produced commodities are less competitive on the world stage when the dollar rallies. As a result, dollar-based prices must fall to match the effective price of global competitors in other currencies.

Regardless of the exact cause, this inverse dynamic has been powerful in recent periods, with at least part of the downturn in commodity indexes over the past few years linked to the bull market in US dollars. 


What happens to this relationship at the individual commodity level?

The degree to which this inverse relationship exists varies materially among individual commodities, and it typically weakens as other factors overwhelm the effect of currency movements. The weather’s influence on crop prices, the lack of true global portability of natural gas, the easy substitution of one type of grain for another—all of these can offset the impact of the strength of the US dollar. 


We see this play out when we study the price performance of WTI crude oil and corn. The price of WTI crude oil is quoted globally in US dollars. It’s easily transported, has few substitutes, and has a relatively constant demand. As a result, its price has a tight link with movements in the dollar. 


Figure 2

Sources: Bloomberg, Parametric, 12/31/2018. For illustrative purposes only. It is not possible to invest directly in an index. They are unmanaged and do not reflect the deduction of fees and expenses. Past performance is not indicative of future results. Please refer to the disclosures for important information.


But such a dramatically close dollar-commodity relationship breaks down when we look at the price of corn. Why? Because unlike oil, corn is heavily affected by seasonality, it has several substitutes, and its price is strongly influenced by the weather.


Figure 3

Sources: Bloomberg, Parametric, 12/31/2018. For illustrative purposes only. It is not possible to invest directly in an index. They are unmanaged and do not reflect the deduction of fees and expenses. Past performance is not indicative of future results. Please refer to the disclosures for important information.


How close is the relationship between individual commodities and US dollar strength?

It varies. For almost all commodities, the chart below returns a negative correlation—meaning commodity prices tend to fall when the dollar strengthens. This reinforces the idea of an inverse relationship between movements in commodity prices and the strength of the US dollar. 


Figure 4

Sources: Bloomberg, Parametric, 12/31/2018. For illustrative purposes only. It is not possible to invest directly in an index. They are unmanaged and do not reflect the deduction of fees and expenses. Past performance is not indicative of future results. Please refer to the disclosures for important information.


However, the magnitude of this correlation varies dramatically, meaning the strength of the relationship between commodities and the US dollar differs by individual commodity. Energy and industrial-metal commodities, which are used globally and whose prices are typically quoted in US dollars, display the most striking relationship. In contrast, those commodities most affected by the weather (like livestock and grains) or that aren’t easily exportable to the global markets (natural gas) have the weakest dollar-commodity relationship. 


The bottom line

Historically, commodity prices have fallen in times of dollar strength and risen in times of dollar weakness. While the power of this relationship varies over time and by commodity, it’s borne out by historical data. 


Unfortunately, it’s not easy to break out the exact magnitude of this relationship when explaining commodity price changes. However, it’s clear that at least a portion of the steep downturn in commodity indexes over the past few years is due to the US dollar bull market. If the dollar were to weaken, it could provide a powerful tailwind to commodity prices for the dollar-based investor. 


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Greg Liebl Headshot

Greg Liebl, CFA, Senior Investment Strategist

Greg drives strategy evolution across Parametric’s Emerging Markets, International Equity, and Commodities strategies. Since joining Parametric in 2010 (originally as an employee of the Clifton Group, which was acquired by Parametric in 2012), Greg has provided portfolio management in the areas of risk and exposure management and customized implementation solutions. He earned a BS in business administration with a finance concentration from North Dakota State University. He’s a CFA charterholder and a member of the CFA Society of Minnesota.

 


The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.

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