If you don’t think the US dollar and commodities such as oil, corn, wheat, and soybeans are intertwined, you’re mistaken. Historically over time, they have shown they are significantly related… inversely!
Generally, when the US dollar strengthens against other major currencies, the prices of commodities tend to go down. Alternatively, when the value of the US dollar weakens against other major currencies, the prices of commodities typically goes up. While this isn’t always the case, it has held true the majority of the time over that last few decades.
There are multiple reasons why the value of the US Dollar effects commodities prices. The main reason is that the US dollar is the reserve currency of the world. Because of its stability, most foreign countries hold US dollars as a reserve asset. That means it’s generally the benchmark pricing mechanism for most commodity trades, and also used for most trades.
With this in mind, let’s take a quick review of your Econ 101 class.
When the value of the dollar drops, it effects commodity prices like this: As the US dollar decreases in value, other currencies typically increase against the dollar and now they can buy more oil that is priced in US dollars. And when demand goes up, prices go up. Foreign buyers have greater purchasing power and this drives commodity prices up.
This relationship isn’t a -100 correlation, but it’s pretty darn close over the last couple years at -90. Yes, commodity prices won’t necessarily tick up or down exactly with every movement of the Dollar Index, but there is a strong inverse relationship that can’t be denied.
So, all you need to remember is this: When the US dollar goes up commodities such as oil will go down. When the US dollar goes down, commodities will go up.