In the world of forex trading, there is no denying that correlations carry a huge degree of weight. Forex traders—both new and established—are trading currencies from all around the globe. These currencies are issued by prominent central banks and play a huge impact within the realm of currency control, international trade, and general investing. What’s pretty much common knowledge is the fact that the value of a particular currency has a direct impact on the economy of the issuing country and vis versa, with it affecting commodities, stock markets, and the spending behaviour of people. A currency’s performance is also directly impacted by alternate factors such as inflation, interest rates, and employment levels.
The following delves into the world of currency and commodity correlations, explaining what they are, along with which ones you should be paying particular attention to.
What Are Commodity Correlations?
The term “correlation” is used to describe when two financial instruments (in the case of the forex market, these would be currencies or commodities like EUR and XAU) move in the same direction, opposite direction, or have no distinct relation. What you’ll find is that correlations come in two forms.
When two currency pairs move in the same direction within the market, it will be described as a “positive correlation”. For example, history has shown that the EUR/CAD and the EUR/USD tend to move in the same direction.
When two currency pairs move in opposite directions, it is known as a “negative correlation”. Picking out an example, the USD/CHF and EUR/USD comprise a commonly known negative correlation, so when the USD/CHF goes up, the EUR/USD drops and vice versa.
The Most Important Commodity Correlations
AUD/USD and Gold
These days, the relationship between gold (XAU) and the Australian dollar (AUD) still remains prominent, even if the dynamics that stand behind the relationship have shifted. Gold has always carried some degree of “haven” status amongst traders, to the point where many run back to it when economic issues become prominent. However, when signs of growth emerge, the exact opposite happens, with Australia—the third-biggest gold producer in the world—being put in the frame. Gold subsequently has a positive correlation with the AUD/USD pairing. In fact, history shows that AUD/USD has had a staggering 80 percent correlation to the price of gold. So, when gold booms, so will the AUD/USD, and when gold dips, the AUD/USD drops.
AUD/USD and Silver
Many seem to believe that AUD/USD and gold is the most important correlation to follow in 2017. While it’s prominence can’t be denied, AUD/USD and silver actually carries more reliability. Australia has huge mining resources and output; thus, its economy is tied to the industry on a large scale. Most people probably aren’t aware of the fact that mining actually accounts for more than 2 percent of the nation’s employment. On top of that, mining contributes to approximately 35 percent of the nation’s exports. What you can take from this is that shifts in the silver market can heavily impact the performance of the AUD/USD.
USD/CAD and West Texas Intermediate (USOil)
West Texas Intermediate (USOil) is the lead form of oil traded in North America and thus holds major influence over the CAD. It is hardly a secret that the US consumes the most amount of oil in the world, averaging around 19 million barrels per day. While Saudi Arabia is considered to be the nation that relies on oil exports the most, that isn’t strictly the case. This is because a third of oil imports actually come from Canada, so out of the 19 million barrels per day consumed in the US, 10 million are produced in house, with a hefty percentage of that 19 million figure coming from its northern neighbour. This means that USD/CAD is intrinsically linked to the value of “black gold”.
USD and the USD Index
Anyone who actively trades USD pairs needs to keep an eye on the US Dollar Index. What the US Dollar Index represents is a blend of varying forex pairs that include the USD, ranking its value against other currencies. Understanding the USD Index can help any trader get a firm grasp on how weak or strong the USD is at any given time. You can use this information to gauge breakouts and so forth that may occur with USD pairs or steer clear of the currency entirely should it be showing signs of fragility. It gives a clear indication if the market move is USD strength/weakness or another market factor.
USD/CLP and Copper
Much like what has been discussed with the above correlations, economies thrive upon the revenue they are able to generate through natural resources. In the case of Chile, that natural resource is copper. This means that CLP exhibits a high degree of correlation with copper prices, largely as the currency’s dependence on it is nothing short of huge. Thus, when any change in copper demand or supply occurs, it directly affects the value of the CLP against the USD. So, when you see a demand slowdown occur, you can expectthat the price of USD/CLP will go us and CLP weakens.
To be an effective forex trader, it’s crucial that you understand how currency pairs and commodities move in relation to one another. For this reason, commodity correlations take on increasing importance, as they can help traders manage their portfolios more appropriately. It doesn’t matter what trading strategy you choose to adopt—you need to keep in mind the correlations mentioned above, as they will help you spot emerging trends and allow you to stay ahead of shifting trends and spot further profit opportunities.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.