U.S. Dollar’s Impact on Commodity Price Trends

On any day that commodities prices move materially, the financial media is quick to ascribe their action to the US dollar. And this oft-discussed causal relationship is certainly logical. With commodities priced in dollars, a stronger dollar will buy more units of any given commodity while a weaker dollar buys less. But countless times as I’ve seen CNBC reporting on this important relationship, I’ve gotten the impression that the talking heads think the US dollar is the primary or only driver of commodities prices. Neither is true of course. Each commodity has its own unique global supply-and-demand profile, the true fundamentals that drive its price. Nevertheless, the fortunes of the US dollar are often a significant secondary driver.

The long-term data readily reveals the secondary nature of the dollar’s role in commodities prices. During its secular bear between July 2001 and April 2008, the key US Dollar Index (USDX) lost a staggering 41% of its value! And if the dollar was the main driver of commodities prices they shouldn’t have rallied significantly more than the 40% weaker currency demanded. Yet between October 2001 and July 2008, the Continuous Commodity Index (CCI) soared 235%. Supply and demand far outweighed the dollar! Still, the US dollar has a disproportionate impact on commodities-trader psychology. The all-important worldwide supply-and-demand data for most commodities is usually merely estimated, is released piecemeal in a haphazard fashion on differing schedules by many unrelated organizations, and is very difficult to synthesize into a tradable whole. Meanwhile, the dollar’s levels are always available in real-time. Thus it is far easier watching the dollar to game commodities rather than delving into their fundamentals.

And with the recent stock panic driving the most extreme market psychology we’ll see in our lifetimes, the dollar’s psychological impact on commodities has temporarily ballooned to monstrous proportions. A panic is a bubble in fear, and fear drives highly emotional trading that is totally divorced from underlying fundamental realities. The dollar’s extreme fear-driven panic behavior, despite being irrational, really drove an unprecedented commodities bloodbath. The carnage was truly epic in scope.