Commodity Currency
Quick Answer
A commodity currency is a currency whose value is considered meaningfully connected to the prices of commodities exported by its economy. The term is commonly applied to currencies of major commodity-exporting countries because changes in export prices can affect trade income, economic conditions, capital flows and demand for the currency.
How does a Commodity Currency work?
The relationship between commodities and currencies often begins with a country's exports.
Suppose an economy exports large quantities of a commodity such as:
iron ore;
crude oil;
natural gas;
agricultural products;
metals.
If the world price of an important export rises, the country may receive more income for its exports.
This can improve its terms of trade, meaning the prices received for exports rise relative to the prices paid for imports.
Higher export revenues can then influence:
demand for the country's currency;
national income;
business investment;
government revenues;
inflation expectations;
monetary-policy expectations.
The Reserve Bank of Australia explains that higher commodity export prices can increase demand for Australian dollars and contribute to currency appreciation. This connection is one reason the Australian dollar is often described as a commodity currency.
Common examples of Commodity Currencies
Currencies frequently associated with commodity-exporting economies include:
Australian dollar (AUD)
Canadian dollar (CAD)
New Zealand dollar (NZD)
Norwegian krone (NOK)
An IMF study examining commodity currencies specifically identified AUD, CAD, NZD and NOK within its dataset based on commodity-export relationships.
However, the list should not be treated as universal.
Whether a currency behaves like a commodity currency depends on factors such as:
the importance of commodities to national exports;
which commodities the country produces;
exchange-rate regime;
monetary policy;
global risk sentiment;
economic diversification.
Research also shows that being a major commodity exporter does not automatically mean commodity prices will explain most movements in its currency.
Simple Commodity Currency example
Suppose Country A is a major exporter of copper.
Copper rises from:
$8,000 per tonne
to:
$9,200 per tonne
The percentage increase is:
($9,200 − $8,000) ÷ $8,000 × 100 = 15%
If copper represents an important share of Country A's exports, the higher price could increase export income and improve its terms of trade.
All else being equal, this could increase demand for Country A's currency and contribute to appreciation.
However, suppose the country's central bank simultaneously cuts interest rates sharply or global investors move away from riskier assets.
The currency could still weaken despite higher copper prices.
This example is illustrative only and does not represent an actual currency, commodity price or FxGrow market forecast.
Why do Commodity Currencies matter to forex traders?
Commodity currencies can help traders understand the relationship between:
foreign exchange + commodities + macroeconomics.
Traders may monitor commodity prices when analysing currencies of commodity-exporting economies because changes in export values can influence economic expectations.
For example, analysis of the Australian dollar may include developments in:
iron ore;
coal;
other Australian export commodities;
Australia's terms of trade.
The RBA has documented a long-standing relationship between commodity prices, Australia's terms of trade and the Australian dollar.
Commodity currencies can therefore provide traders with another macroeconomic variable to consider alongside interest rates, inflation, employment and central-bank policy.
Risks, limitations and common misconceptions
A common misconception is that:
Commodity price rises = commodity currency rises.
The relationship is not that simple.
Exchange rates are influenced by many variables, including:
interest-rate differentials;
central-bank expectations;
economic growth;
inflation;
capital flows;
political developments;
market positioning;
global risk sentiment.
Commodity prices are only one potential influence.
Another misconception is that every currency issued by a commodity-producing country qualifies automatically as a commodity currency.
Research generally focuses on currencies where commodity prices have a meaningful relationship with exports, terms of trade or exchange-rate behaviour. IMF research has found that strong long-run commodity-price relationships appear in only a portion of commodity-exporting economies.
Commodity correlations can also change over time. Economic diversification, shifts in trade patterns, monetary policy and global financial conditions can strengthen or weaken the historical relationship.
Finally, the term commodity currency describes an economic relationship. It does not mean that the currency itself is backed by gold, oil or another physical commodity.