In international finance and trade, commodity currencies play an important role in shaping the dynamics of global economies.
These currencies, often also referred to as “resource-based currencies,” derive their value and stability from the exportation of key commodities such as crude oil, gold, copper, and agricultural products.
Typically, nations with abundant natural resources and significant export-oriented economies, such as Australia, Canada, Russia, and several African and South American countries, have currencies that exhibit strong correlations with the fluctuations in global commodity prices.
The concept of commodity currencies is not new, but its importance has grown due to the increasing interconnectedness of global markets, the rising demand for raw materials, the strategic importance of certain raw materials, and the evolving macroeconomic landscape.
These currencies serve as an important link between the global demand for commodities, the supply chains of them, and the economic health of resource-rich countries.
In this article, we’ll provide an overview of the factors that drive commodity currencies, their significance in international trade and finance, and the risks and opportunities associated with them (e.g., when is it good to buy and sell them?).
Key Takeaways – Commodity Currencies
- Commodity currencies derive some their value from the exportation of key commodities and may be highly sensitive to fluctuations in commodity prices.
- Commodity currencies serve as a link between the global demand for commodities, the supply chains of them, and the economic health of resource-rich countries.
- Understanding the nuances of commodity currencies can help investors/traders identify investment and trading opportunities and policymakers manage risks associated with currency movements.
Commodity Currencies List
Commodity currencies are those of countries whose economies are heavily dependent on the export of natural resources.
Some common examples of commodity currencies include:
- Australian Dollar (AUD)
- Canadian Dollar (CAD)
- New Zealand Dollar (NZD)
- Norwegian Krone (NOK)
- Russian Ruble (RUB)
- Brazilian Real (BRL)
- South African Rand (ZAR)
- Chilean Peso (CLP)
Types of Commodity Currencies
Commodity currencies can be categorized based on the type of commodity that dominates the country’s exports:
- Energy-based currencies: e.g., Canadian Dollar (oil and gas)
- Metal-based currencies: e.g., Australian Dollar (iron ore, gold)
- Agricultural-based currencies: e.g., New Zealand Dollar (dairy products)
Commodity Currency vs. Term Currency
A commodity currency is one that is influenced by the value of a specific commodity, while a term currency refers to the base currency in a currency pair.
In the foreign exchange market, major currencies like the US Dollar, Euro, Yen, and British Pound are usually considered “term currencies.”
They are global reserve currencies (to varying degrees) and often act as reference currencies in FX pairs. The USD is the most popular, followed by the EUR.
Commodity Prices and Currency Movements
Commodity currencies tend to be sensitive to fluctuations in commodity prices.
How sensitive depends on the exact nature of their economies.
As commodity prices increase, the value of the exporting country’s currency also tends to rise due to higher demand for their exports.
Conversely, when commodity prices fall, the currency’s value may decline as export revenues decrease.
A commodity-backed currency is not the same thing as a commodity currency.
A commodity-backed currency is a currency that is directly pegged to the value of a specific commodity, such as gold or oil.
(For example, the USD was a commodity-backed currency under the Bretton Woods system from 1944 to 1971. It’s been a fiat money system since.)
This type of currency is different from fiat money, which has no intrinsic value and is not backed by a physical commodity.
In a fiat money system, money creation is simply based on the demand for it so we don’t have to physically barter.
Commodity Currencies and the Real Exchange Rate
The real exchange rate measures the value of a currency relative to another, adjusted for inflation.
Commodity currencies naturally have a dependence on commodity prices, which influences inflationary pressures.
Commodity Currencies and Equity Flows
Investors/traders often consider commodity currencies when making decisions in the equity market.
A strong commodity currency can be an indicator of a healthy economy, leading to increased investment in equities within the country.
When you own a stock, you own a pile of that currency.
So if you were to own a Canadian stock as a non-CAD investor with no FX hedge, you’re also making a bet on oil prices considering Canada is an oil exporter and that influences the value of its currency.
A financial asset in a foreign currency is the returns + currency.
If you’re making 7% per year on the financial asset, but the currency is falling relative to your domestic currency by more than 7% per year, you’re losing money.
A weak commodity currency may signal economic difficulties, prompting investors to divest from the country’s equity markets.
Commodity Currencies Basket
A commodity currencies basket is a collection of currencies from countries that are major commodity exporters.
This basket is often used as a benchmark to track the performance of commodity currencies or as an investment tool to gain exposure to the commodity market.
G10 Commodity Currencies
G10 commodity currencies are the currencies of the Group of Ten countries, which are major advanced economies.
Among these, the Canadian Dollar, Australian Dollar, and Norwegian Krone are considered commodity currencies due to their reliance on natural resource exports.
Commodity Currencies in Emerging Markets
Emerging market commodity currencies include those from countries like Brazil, Russia, South Africa, and Chile.
These currencies are often more volatile than those of developed economies due to various factors, including political instability, lower liquidity, and weaker economic fundamentals.
Safe-Haven Commodity Currencies
Safe-haven commodity currencies are those that investors turn to in times of wider-than-normal market expectations or market volatility.
While traditional safe-haven currencies include the US Dollar, Swiss Franc, and Japanese Yen, some investors also consider the Canadian Dollar and Australian Dollar as safe-haven options due to their strong economies and stable political systems.
Climate Risk and Commodity Currencies
Climate risk is an emerging concern for commodity currencies, as the effects of climate change can have a significant impact on the value of these currencies.
Commodity currencies, such as the Australian dollar, the Canadian dollar, and the New Zealand dollar, are heavily reliant on the prices of commodities such as oil, gas, and minerals for their value.
If the production and export of these commodities are disrupted due to climate policy, it can cause a decline in their prices. This can lead to a decrease in the value of commodity currencies, as the demand for these currencies falls.
Governments and central banks of commodity currency countries are also taking steps to address these risks. For example, the Bank of Canada has included climate risk as one of the key risks to financial stability in its annual report, and the Reserve Bank of New Zealand has incorporated climate risks into its stress testing framework.
FAQs – Commodity Currencies
What are some examples of commodity currencies?
Some examples of commodity currencies include the Australian Dollar (AUD), Canadian Dollar (CAD), New Zealand Dollar (NZD), Norwegian Krone (NOK), Russian Ruble (RUB), Brazilian Real (BRL), South African Rand (ZAR), and Chilean Peso (CLP).
Is CAD a commodity currency?
Yes, the Canadian Dollar (CAD) is considered a commodity currency due to Canada’s economy being heavily dependent on the export of natural resources, particularly oil and gas.
What are commodity currency pairs?
Commodity currency pairs are forex pairs that involve at least one commodity currency.
Some common commodity currency pairs include:
- AUD/USD (Australian Dollar/US Dollar)
- USD/CAD (US Dollar/Canadian Dollar)
- NZD/USD (New Zealand Dollar/US Dollar)
- USD/NOK (US Dollar/Norwegian Krone)
- USD/RUB (US Dollar/Russian Ruble)
- USD/BRL (US Dollar/Brazilian Real)
- USD/ZAR (US Dollar/South African Rand)
- USD/CLP (US Dollar/Chilean Peso)
Does a commodity currency mean a country exports commodities?
Yes, a commodity currency generally refers to the currency of a country that relies heavily on the export of commodities, such as energy resources, metals, or agricultural products.
The value of these currencies tends to be closely tied to fluctuations in commodity prices, which can affect their exchange rates.
Commodity currencies play an important role in the global economy, reflecting the importance of natural resources and the countries that produce and export them.
As these currencies tend to be highly sensitive to commodity price fluctuations, they can provide valuable insights into the health of the global economy and the demand for essential goods.
Investors, traders, and policymakers should be aware of the nuances of commodity currencies, including their correlation with commodity prices, their role in forex markets, and their impact on equity flows and real exchange rates.
Understanding the relationship between climate risk and commodity currencies is also becoming increasingly important as the world grapples with the consequences of climate change.
By monitoring the performance of commodity currencies, market participants can gain a deeper understanding of global economic trends, identify investment opportunities, and manage the risks associated with currency movements.