QE, Currencies and Commodities

by Marc Chandler

One of the market developments that is capturing the imagination (and wallets) of investors is the rally in commodities. As an example, since late Aug ’10, when Fed Chairman Bernanke seemed to signal QEII and US economic data began improving more noticeably, the CRB index has rallied about 30%. Roughly a third of the gain was recorded since late Nov.

If one is bullish commodities, one can simply buy those commodities. This is especially true for equity investors given the various ETFs. However, often foreign exchange market participants are look ways to express (or hedge) commodity views in the currency markets. At the same time, there is a bit of a debate in the academic work as to what leads and what lags. For example, some work suggests that currencies adjust faster than real activity and that as a consequence stronger so-called commodity currencies lead the movement of commodities, rather than the other way around, where, for example, some participants may want to buy Australian dollars after gold prices have rallied.

We took a look at three commodities, gold, oil and copper,and looked at currency correlations with them. We performed our calculations on percentage change and log normal basis. The currencies we looked at were: AUD, NZD, GBP, Euro, JPY, BRL, NOK, ZAR, MXN, CLP and CAD.

Gold: Over the past 3 and 6 months, the New Zealand dollar was most correlated with gold prices. In the past 3-months, the correlation was 0.615 vs Australian dollar (2nd place) of .598. Much to our surprise, we found that sterling was the third most correlated with gold over the past three months at 0.540. The rand was 0.49 and the Canadian dollar was 0.46. In the past 6-months, the rand and real edge out sterling, but NZD and AUD are the most correlated.

Oil: In both periods, the Canadian dollar was the most correlated with oil prices. In the past three months the correlation stands at a high 0.74, while over the past six months it is 0.645. The Australian dollar is in second place, with 0.635 and 0.615 respectively. The Mexican peso comes in third in both periods at 0.556 and 0.55 respectively. We found, to our surprise, the New Zealand, which came in fourth at 0.502 and 0.542 respectively, was more correlated to oil than oil producers like the UK and Norway.

Copper: Over the past three months, the Chilean peso enjoyed a 0.548 correlation with copper prices. This is the most of the currencies we looked at, but over the past six months, the Chilean peso (0.496) slipped into third place behind the Canadian dollar (0.515) and the Australian dollar (0.498). In the last three months, the Mexican peso was second most correlated to copper behind Chile (0.497),but slipped to 4th place over the six month period (0.465).

There were several unexpected results. We are surprised the NZD and gold are higher correlated that AUD or ZAR. We were surprised too by sterling’s correlation, especially over the past three months. Perceptions of the Canadian dollar as a commodity currency appear to be borne out by this simply work, but the strength of the correlation with oil was higher than we anticipated a priori. The correlation between NOK and oil (less than 0.50 in both periods) was weaker than we had expected. That CLP is correlated with copper prices over the past three months is not surprising; rather the surprise is over the 6-month period the correlation slips below 0.50. Outside of the past three months with Canadian dollar and oil (0.74), the other correlations we found, while interesting, are still too low and unstable to offer a good proxy to acquire or hedge commodity exposures.