A mix of bellwether global macroeconomic indicators is showing that the United States Dollar (USD) may be entering into weak territory.
Although, this should concern all who hold the USD as an investment or a store of value, it has farther reaching implications (including for players in the commodity space including traders and producers of crude oil, metals, etc).
As Kitco.com, a commodities investment website explains, when the USD gets stronger or appreciates, it takes fewer dollars to buy a given amount of a commodity (priced in USD). And when the USD gets weaker it takes more dollars to purchase the same amount of that commodity.
The price of USD denominated commodities, such as gold, will change to reflect the strength or weakness of the USD. So it’s quite possible, in fact it’s almost always the case that a portion of the change in the price of commodities like gold is really just a reflection of a change in the value of the US Dollar. Sometimes that portion is insignificant. But often the opposite is true where the entire change in the commodity price is simply a mathematical recalculation of an ever-changing US Dollar value.
When the dollar is strong, the price of commodities like gold, oil, and other safe haven investments/currencies, appears to fall, and the price of these assets appear to rise when the USD weakens.
Gold and other safe haven investments
The movements in the value of the USD accounts for a part of the fluctuations that we see in the value of commodities.
Another part of the change in their value is of course due to an actual change in their demand or supply. Usually, when investors perceive increased volatility in the USD (which is the most common safe haven currency), they tend to exit and pile into other safer safe haven investments. This increased demand translates into higher prices of the currencies/assets/commodities relative to the USD.
Safe haven assets mostly favored by savvy investors include commodities like gold, and currencies like the Japanese Yen (due to the stability of its economy, and the extreme cheapness of borrowing in Yen to fund carry trades). Others like the Euro, Swiss Franc, British Pound are also in favor.
A comparison of the recent price trend of these favored investments/assets relative to the USD is instrumental in helping us determine where the value of the USD sits in the wider scheme of things.
Tying it all together
The value of the USD and the price of commodities tend to move in opposite directions, hence, a look at one side of the scale can tell about what is happening in the other.
The value of gold as a proxy for the value of the USD
Stripping the change in the price of gold which comes as a result of USD fluctuations from that which comes from a rise or fall in demand of the commodity is key in determining the value of the USD.
If the gold price is higher when being measured not only in US Dollars, but also in Euros, Pounds Sterling, Japanese Yen, and every other major currency, then we know the gold demand is higher and it has actually increased in value.
Consequently, if gold is higher in USD while at the same time cheaper in every other currency, then we can conclude that the USD has weakened, and that gold has actually lost value in all other currencies. But the price, because it is being quoted in USD will be higher and give the illusion of gold becoming more valuable. In such a case the devaluation of gold, due to increased supply on the market, is camouflaged by a weakened US Dollar.
Some charts help to shed more light:
Chart 1.0 USD Index
The USD index shows a falling trend.
The above chart shows USD index chart, if the RSI eventually breaks below the green support line. This could lead to serious inflation which is good for precious metals and commodities. Also note that if the RSI falls below 50, it will lead to drastic collapse in the USD strength.
The above chart shows the correlation between the strength of the US Dollar and Crude oil. You can observe that during the last three months when the US Dollar weakening, oil price began to gain strength. Remember the USD Index chart is already pointing towards a further weakening of the USD, could this mean that oil price has seen its bottom? Maybe.
The above chart shows the correlation between the US Dollar and Japanese Yen. You can observe that the recent USD/JPY broke down around December 2015. What does this mean? It means the Japanese Yen began to strengthen against the US Dollar, showing weakness in USD. Investors are dumping their USD denominated assets for JPY assets. If you will like to know why this is happening you can read more here:
The above chart shows gold. It is a classic breakout (buy signal) for a bullish trend. Could this be a rush for safe haven?
GOLD VS USD/JPY
The above chart shows the correlation between Gold and USDJPY. We can see that whenever we see a bullish breakout in gold it becomes bearish for USDJPY vice versa. History shows us that when we see the JPY strengthen significantly against USD, gold also strengthens. This is a rush for safe haven assets.
When the dollar falls, we see inflation which reflects as a higher price in precious metals and commodities. It’s time to own hard assets or have shares in companies that produce hard assets. e.g stocks in quality mining companies, profitable farms, buying precious metals, land etc
My take on crude oil: Crude oil may not have a smooth ride to the top because of trade wars currently being experienced. If you must own shares in oil companies, then you need to be patient, not get worried over volatile oil price.
You may want to know if the USD collapse will translate to a stronger Naira since oil price may start ticking higher in months to come. In my opinion, I do not think so. Reason because Nigeria has internal problems and it may take a long time before the profitable oil price gets priced into the Naira unlike other currencies like the Canadian Dollar.