There are a number of variables that drive commodity prices, and at any one time that mix of factors will vary depending on the global economy, specific country performance, and supply and demand fundamentals, to name but a few.
But one variable that has had a consistent impact over time has been the strength of the U.S. dollar relative to other currencies.
A strong dollar is bearish for commodity prices, as the dollar-priced commodity costs more in other currencies when the dollar exchange rate is strong. Conversely, the reverse is often true — a weakening of the U.S. dollar will see a rise in commodity prices.
So while it is far from the only driver of price, keeping an eye on the exchange rate and holding a sense of trend direction for the currency can be a useful indicator of price direction.
As the Financial Times notes, the U.S. dollar has performed poorly so far this year, falling about 6% on a trade-weighted basis. Investors were wrong-footed, the Financial Times states, early in 2017 when they bet that U.S. tax reform would push the dollar beyond already lofty valuation levels and help the American economy continue to outperform the rest of the world.
In support of our argument, metal prices have performed well this year, as the dollar has weakened. Where the dollar goes from here could have a bearing on whether the market continues to rise or goes in reverse.
The Impact of Proposed Tax Reforms
The dollar has followed the fortunes of the market’s view on President Donald Trump’s proposed tax reforms.
From the time he won the election through to the end of last year — when tax reform was much in the news and markets first considered the benefits of tax cuts and repatriation of foreign-held profits — the dollar strengthened some 5%.
Since then, it has depreciated steadily, hitting a 33-month low last week, according to another Financial Times article.
Much of that decline has been due to the market’s perception that growth is slowing in the U.S., while at the same time the prospects of tax reforms have dwindled in the face of a divided Congress.
At the same time, growth and confidence have picked up in Europe. The Euro, the world’s second-most highly weighted currency, has done correspondingly better.
Growth in Asia has also remained more robust than observers may have expected 12 months ago. At the same time, the market’s expectation of a December Fed rate rise has fallen to less than 30% probability with next June the more likely date. Meanwhile, in Europe the talk is more about rolling back quantitative easing.
The dollar’s performance could be transformed if Congress could agree on tax reforms. Even if many economists disagree on the actual benefits of the income tax reforms, most agree the repatriation of foreign profits holiday would have a profound impact on the economy and the dollar.
At present, agreement on anything seems a long way from probable.