Dollar and commodity prices.

The world has been talking about de-dollarization for a long time now, but implementing the planned measures isn't as easy as it looks. Dethroning the dollar as the world's reserve currency is like the 9th wounder. Everyone fantasizes about it, but no one has the ability to do it. The dollar has so much dominance that if the FED (US Central Bank) stopped circulating the dollar, we would literally die of hunger or hyperinflation. Reducing the dollar supply is like reducing the oxygen content of the atmosphere. More than 80% of global trade is conducted in dollars. If the FED decreases the supply, global trade would be significantly affected, leading to increased import prices, followed by a big cut to our wallets. Dollar has been a dominant currency since the second world war. 

Even though major countries like Australia, Saudi Arabia, Russia, Singapore, India, and Sri Lanka have been talking about using the Indian rupee as an alternative, the dream is still in the initial stages. Every object out there, may it be petroleum, cotton, rice, etc., is affected because of the dollar's strengthening. Since de-dollarization is still miles away, knowing about the effects that the dollar has on various commodities is key because the stock markets and the commodities markets are interrelated. In fact, commodities were traded prior to stocks, and considering commodities as an underling, the stock markets were designed and still run in accordance with the commodities markets. The cyclicality that we experience in various businesses like steel, cement, etc. is all an outcome of commodities and the dollar. Hence, let's dive deeper into the inverse relationship between the dollar and commodity prices. 

Historically, the prices of commodities have tended to drop when th dollar strengthens against other major currencies, and when the value of dollar weakens against other major currencies, the prices of commodities generally move higher. This is a general rule, and the correlation isn't perfect, but there's other significant inverse relationship over time. If you look at a chart of the Commodity Research Bureau (CRB) Index, it tracks a diverse group of commodities prices against a chart of the dollar index. This represents the strength or weakness of the U.S. currency against other foreign exchange instruments.

WHY THE MOVEMENT? 

The primary reason the value of dollar influences commodities prices is that the dollar is the benchmark pricing mechanism for most commodities. Being the reserve currency, the dollar tends to be the most stable foreign exchange instrument, so most other nations hold dollar as reserve asset. When it comes to international trade for raw materials, the dollar is the exchange mechanism in many if not most cases. when the value of dollar drops, it costs more dollar to buy commodities. At the same time, it costs a lesser amount of the other currencies when the dollar is moving lower. 

COMMODITIES ARE GLOBAL ASSETS

Another reason for the influence of the dollar is that commodities are global assets. They trade all over the world. Foreign buyers purchase US commodities such as corn, soyabeans, wheat, and oil with dollar. When the value of dollar drops, they have more buying power, because it requires lower amount of their currencies to purchase each dollar. Classic economics teaches that demand typically increases as prices drop. 

                                    

DOLLAR IS A BENCHMARK BECUAUSE OF ITS STABILITY 

Commodities don't trade in a vacuum. Commodities production is often a localized affair. The majority of corn and soyabeans production in the world comes from the fertile lands of the US. The mineral rich soil of Chile yields highest output of copper on earth, and half the world's oil reserves are located in the middle east. The largest producers of cocoa beans are in Africa, in the Ivory Coast and Ghana regions. The vast majority of these materials use the dollar as a pricing mechanism for global trade because of the United States's strong, stable economy. When the dollar strengthens, commodities become more expensive in other, non-dollar currencies. This effect tends to have a negative influence on demand, and as you would expect, when the dollar weakens, commodities prices in other currencies drop lower, which increases demand. 

Each commodity has idiosyncratic characteristics, but the value of the dollar has historically had a direct influence on the prices of all commodities. When the dollar began to strengthen in May 2014, the US dollar index traded to 78.93 on the active month futures contracts. In early March 2016, the dollar index was trading at around the 97 level; the dollar had appreciated by around 23% in less than two years. 

DOLLAR INDEX - The dollar index tracks the relative value of the U.S. dollar against a basket of important world currencies. If the index is rising, it means that the dollar is strengthening against the basket - and vice-versa. Currencies included in the index are the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. 

One of the best ways to hedge against change, and to keep a close eye on the value of the dollar and its correlation with commodities, is to watch the price quotes of the US Dollar index. Commodities prices don't necessarily tick higher for every tick lower in the dollar index, but there's often been a strong inverse relationship over the long haul. Individual commodities have fundamental supply and demand characteristics, so they move one way or another at times, regardless of the direction of the US currency. Risk aversion plays a part, particularly in recent events. Keep eye on the situation, and don't take the previous trends for granted. Remember, history never repeats but it rhymes.