A Good Relationship Gone Bad…

| March 3, 2010 | 0 Comments

Sometimes relationships hold strong for the long haul… and sometimes good relationships take a turn for the worst.

Like a budding romantic relationship, the relationship between the U.S. Dollar and commodities is complex.

You see, the financial media (CNBC and the like) will tell you a rise in the dollar translates directly into cheaper commodity prices.  They state this with such certainty, many investors see this purely as cause and effect. A rise in the dollar means a drop in commodities, and vice versa…

The talking heads on TV are clearly rehashing their college economics textbooks (if they even took economics).  They’ll lead you to believe that the dollar is a primary mover of commodities.

Now, to their benefit, basic economics will tell you that a falling dollar is inflationary.  As the value of the dollar goes down, commodities priced in the dollar go up.  Most things we rely on for everyday life gets more expensive.  It takes more dollars to buy those commodities.

But something very interesting has been happening lately…

A couple of weeks ago the dollar was rallying… but so did gold, silver, and oil.  And in the past week, the U.S. Dollar has been holding steady… but the price of gold, silver, and oil is still going up.  It seems the widely accepted inverse relationship between the dollar and commodities isn’t always true.

In fact, there are times when the dollar and commodities move in sync.  As one goes up, so does the other.

This is a chart of the U.S. Dollar plotted against the CRB Index.  The CRB is an index of commodities.  It includes commodities from across the board… gold, silver, oil, aluminum, cotton, orange juice, etc.

As you can see, the dollar and the CRB Index moved in tandem for the better part of 1999 and 2000.  As one rose, so did the other.

Let’s fast forward to 2008 and 2009…

As you can see, the relationship changed.  Once again, a fall in the dollar translates to a rise in commodities.  Looking at this chart, you can see why many people believe the relationship is always inverse.

But the relationship isn’t set in stone… Over the last couple of weeks, the dollar/commodity relationship has switched back to a direct relationship. Both are going up at the same time.

I don’t know how long this will last, but it’s important to keep an eye on. Is it a sign of things to come?  Well, it could be.  It’s very tough to predict how this will play out in the next few months.

When both the dollar and commodities rise, the markets are telling us something…

It may be pricing in future inflation.  It could also be pricing in future lack of supply for respective commodities.  (But more importantly, maybe the smart money knows the gig is up for fiat currencies.)

We could be looking at higher commodity prices if stuff like gold, silver, and oil continue to rally or even hold steady on a strong dollar.  When the relationship switches back to inverse and the dollar falls… commodities will rally from an already inflated price.

The bottom line is this…

The relationship between the dollar and commodities can switch back and forth.  Individual commodities move on much more than U.S. Dollar strength and weakness.

The individual supply/demand picture, as well as other underlying economic factors, plays a larger role than media will lead you to believe. Media presents these simple cause and effect relationships as a way to justify movements in the markets.

Don’t assume what’s good for the dollar will always be bad for commodities.

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Category: Commodities

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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