Weak Dollars and Strong Commodities

January 13, 2011 by Jim Prince

Many market analysts believe there is an inverse relationship between the value of the United States dollar and the price of commodities. It isn’t uncommon to see headlines like these:

“U.S. Dollar’s Weakness Boosts Commodity Prices”

“Weaker Dollar Boosts Oil, Gold & Silver”

Some analysts claim this relationship is so powerful it outweighs the effect of fundamental factors. Others say the relationship is secondary to fundamentals like supply and demand. Some say the relationship is causal. Others say it is psychological, affecting the perception of traders. With so many opinions, whom do you believe?

As a technical trader, I always prefer to go to my charts and see what they tell me. I’m not so much interested in why such a relationship may exist. I’m interested first to see for myself whether such a relationship does in fact exist. Then I can decide how to use this knowledge to improve my trading success.

So let’s begin by looking at two charts that provide the easiest way to decide whether or not there really is a relationship between the value of the U.S. dollar and commodity prices. First we’ll look at the daily chart for the U.S. Dollar Index. We’ll look at a weekly chart, which gives us a more long-term picture than the daily chart.

Now let’s compare that with the chart of the CRB Continuous Commodity Index cash market, which is composed of data from a group of commodities that are believed to be the first to react to changing economic conditions.

When you look at these two charts together, the inverse relationship is quite noticeable.

In early to mid-2007, both charts are trading in their mid-range. From there, the U.S. dollar drops to a series of lows, while the CRB rises to highs. From mid-2008 the CRB steeply plunges from its high, reaching its low in the third quarter of that year. During that same time period the U.S. dollar soars to new highs. It then dips and hits a second high in early 2009. It then starts a steady downtrend until it hits a new low toward the end of 2009. By contrast, from 2009 to 2010 the CRB moves steadily upward. Then comes 2010. The U.S. dollar shoots up to a new high in mid-year, and then falls. Again, in contrast, during 2010 the CRB drops to a minor low (corresponding in time to the U.S. dollar high) and then soars to new highs. The two charts are almost mirror images of one another.

Now let’s look at the charts of some specific commodities to see whether they show the same pattern. Let’s start with the weekly chart for gold.

Although the range of the highs and lows varies between gold and the CRB, the shapes of the charts are very similar, with highs and lows being made within the same time frame.

Now let’s look at the weekly chart for corn, an example from the grain sector.

The corn chart is very similar to the CRB chart, with highs in mid-2008 and lows in the third quarter of 2008. Whereas the CRB chart then entered a steady climb, the corn chart remained in a trading range before starting its climb in 2010. The charts look very similar from mid-2010 to the present.

The story is the same for a number of other commodity markets. If you’re interested, you might check out the charts for crude oil, coffee and sugar, for example.

Now let’s look at some daily charts to get a closer-in look. Look at the chart of the March 2011 U.S. Dollar Index.

We see that over the four months from September through December, prices dropped to a low in early November; then they rose to a high in late November; and then entered into a mid-level trading range.

Let’s compare that to the same time period in the CRB CCI Index cash market.

In early September, while the U.S. Dollar Index was high and then began to drop, the CRB Index started low and began to rise. It hit a high in early November that corresponds to the low in early November made by the U.S. dollar. CRB prices then dropped to secondary lows in mid to late November, at the time that the U.S. dollar was heading for a high. After that CRB prices rose steadily, while the U.S. dollar Index entered a mid-level trading range.

Judging by these daily charts, it looks like the inverse relationship between commodity prices (as represented by the CRB Index) and the U.S. dollar seems to be holding for the short-term, as well as the long-term.

What does this mean to traders? Well, we can’t say for sure what causes this relationship, but we can see that it exists. If the U.S. dollar is making a big move, there’s a good possibility the commodity markets will be moving in the opposite direction. So, when we see the U.S. dollar moving, that can be our signal to check the commodity markets and consider trading them in the opposite direction from the dollar. This assumes an examination of the charts reveals that all the correct signs are there. And, of course, always take the right steps to manage and protect your position.

– Jim Prince