Beginners in trading, often ask why the U.S. dollar affects the price of many commodities in the market. To answer this question, it is important to understand first what a reserve currency is.
Reserve currencies are currencies that are stored by Central banks and major financial institutions in very large quantities. These currencies are used for major investments, massive transactions, and all aspects that are related to the global economy.
One of the most notable reserve currency in the world is the U.S. dollar. It is widely known for its liquidity and it is the currency of America, one of the world’s most powerful and stable economy. Commodities are usually priced in reserve currencies. Gold, oil, steel, platinum and many others are priced with the U.S. dollar. Oftentimes, commodity buyers use the U.S. dollar to purchase various commodities. Thus, a sudden change in the price of the dollar can widely affect a number of commodities in the market.
Commodities and the U.S. dollar have an inverse correlation. If the price of the dollar rises then commodity price falls and if the price of the dollar decreases then commodity prices increase. An increase in the U.S. dollar value indicates that the buyer will have to spend more of their own currency to purchase a certain amount of a commodity. When commodities become more expensive its demand will fall resulting in a price decrease.
Every commodity has its own peculiar attributes. These attributes often affect the price of various commodities. But the value of the dollar has a superior influence on commodity prices compared to the different attributes of commodities. Even history has its testimonies with the inverse relationship between the U.S. dollar and commodities. In the year 2014, a significant number of commodity prices fell when the dollar appreciated by approximately 23%.
As a trader, it is important to always monitor the price of the dollar and even the aspects that will affect its price. It is common knowledge that commodities and the U.S. dollar move in opposite directions. This insight doesn’t assure a specific investment decision but it can guide in making reliable decisions.
Another reason for the influence of the dollar is that commodities are global assets. They trade all over the world. Foreign buyers purchase U.S. commodities such as corn, soybeans, wheat, and oil with dollars. When the value of the dollar drops, they have more buying power because it requires less of their currencies to purchase each dollar.