Advisory Blog
Mirror, mirror: Inverse relationship between commodities and the US dollar

Timely insights on the issues that matter most to investors.

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 Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. 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 Posts
  • More
    Topics
      Authors

      Filter Insights by Date:   Start Date   End Date   or  Show recent results
      The article below is presented as a single post. Click here to view all posts.

      By Greg Liebl, CFAPortfolio Manager, Parametric

      Seattle - 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 with the immediate surge in oil prices when Saudi oil facilities were attacked, geopolitical events can also play a role.

      Yet one of the biggest factors that drive overall commodity prices is likely in our wallets right now: the U.S. 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.

      If we compare the ICE U.S. Dollar Index (DXY) with the Bloomberg Commodity Index (BCOMTR), a common benchmark index for commodity performance, we can see how strongly the price level of commodities and the strength of the U.S. dollar mirror one another. Time and again, charts like this illustrate that when the dollar falls, commodity prices tend to rise, all else equal, with the reverse occurring in periods of dollar strength:

      MirrorFigure1@680px

      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? 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 U.S. dollar:

      1. Real assets, such as commodities, have an intrinsic value, and when the 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 U.S. 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 U.S. dollar.

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

      It varies. For almost all commodities listed on the x-axis, the chart below shows a negative correlation on the y-axis—meaning that 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 U.S. dollar:

      MirrorFigure2@680px

      Sources: Bloomberg, Parametric, 12/31/2018. Commodity prices on x-axis, correlation with U.S. dollar on y-axis. 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 dollar differs by individual commodity. Energy and industrial-metal commodities, which are used globally and whose prices are typically quoted in U.S. 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.

      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 U.S. dollar bull market. If the dollar were to weaken, it could provide a powerful tailwind to commodity prices for the dollar-based investor.