And in the currency world, these super-cheap commodities have everyone wondering if the currencies known as the “com-dollars” can actually rally when the big headline commodities are sinking.

In fact, a fellow investor asked me about that the other day. Great question. Let’s take a look…

The Bipolar Commodity Currency Doesn’t
Always Follow the Rules

Canada is the closest, so let’s start with our neighbor to the north. I call the Canadian dollar a “bipolar” currency because it doesn’t always follow the rules.

It’s true that the Canadian dollar sometimes takes its lead from commodities (because the Canadians are heavy commodity exporters for resources like oil, lumber, etc).

But this bipolar currency doesn’t always track commodities. In fact, there are times that it doesn’t matter what commodities are doing. Here’s why: Canada’s “biggest customer” is the United States. So if traders believe the U.S. is slowing down, then the demand for Canada’s commodities will dry up.

If Canada’s economy slows down, the currency will feel the pain too. Remember, in the end, a currency’s price reflects the collective thoughts of investors all over the world.

All over the world, individuals are casting their votes “for” or “against” a currency based on what they think of the underlying country as a whole.

Note: There are exceptions to this rule but, in general, that holds true in the majority of cases.

So with all of that said, let’s take a look at the USD/CAD pair and we will overlay the chart of oil on top of it.

The Bipolar Currency Sometimes Tracks the Dollar, Sometimes Tracks Oil

Remember that when the USD/CAD chart goes up, the dollar is strengthening and the Canadian dollar is actually weakening. So if the Canadian dollar and oil always head in the same direction then oil and USD/CAD should have an inverse relationship to each other.

But we can look at the chart above and tell that there are times when that is not the case. In fact, there are times when these currencies “disconnect” from the commodities they are known for exporting.

Did the CAD Just Not Notice We Had $147 Oil?

A good example of this is the first eight to nine months of this year. The USD/CAD traded in a boring, sideways range while oil knocked out “never seen before” highs.

Now if there were ever a time for the CAD to rally against the dollar, it would have been then (on the graph above, that would look like an all-time low for the USD/CAD because the U.S. dollar would have dropped versus the loonie).

So what happened? Well, traders realized that this HUGE run up in oil was bound to significantly slow down the U.S. economy. And if it did, then it would by default, also slow down Canada’s economy because Americans would need less of Canada’s oil.

After all, if the U.S. economy slows, so does the movement of goods. If there is less demand for goods, then there are fewer goods that need to be made and shipped across the country and the world.

All of the sudden there is less demand put on 18 wheelers, UPS, FedEx, ocean liners, cargo ships, etc.

This slowing of demand also eases up the demand put on oil supplies. When it does, the U.S. economy slows and so does Canada’s economy. That’s why you get those areas on the charts where it seems like a commodity “de-links” from the major commodities that they export.

So the answer for the Canadian dollar is: Yes, theoretically, the Canadian dollar could rally even when we’re seeing US$50 oil.

Can the Aussie Dollar Also Break Away from Gold?

Okay, so what about Australia? Does the same thing happen with them too or is this just unique to Canada and oil?

Well, let’s look at that for a moment. First of all, it’s important to note that gold is one of Australia’s biggest exports. There are often huge correlations between the Aussie dollar (AUD) and gold. However, there are periods of disconnect there as well.

Let’s take a look at the chart below that goes back about four years.

Sometimes Commodities “Disconnect” from Their Currencies

If gold and the Aussie dollar always correlate, then the AUD/USD and gold should always head in the SAME direction. They often do. However, there are exceptions. I drew yellow arrows on the graph above to show you the exceptions to this rule.

For instance, in 2005 the Aussie dollar actually traded OPPOSITE of gold’s price. This means the U.S. dollar and gold both rallied at the same time, in the same direction. While that doesn’t happen often, it does happen.

Also, I’d like to point out how gold and the Aussie dollar have acted this year – particularly from about July up until now. Notice that most of the time, the AUD/USD and gold have similar “magnitudes.” In other words, they both rose and fell at a great degree.

In recent months, gold had a decent fall… but the AUD/USD just got absolutely unduly punished.

In fact, the AUD/USD pair has fallen about twice as much as gold has. So this shows that not only can their directions move differently (like in 2005) but also the magnitudes of these two can vary as well.

Com-Dollars Can Break Away from Commodities

So what do we draw from all of this? Through the years, many times the com-dollars will correlate with their underlying commodities. BUT there are long periods when this simply does not happen. In fact, the com-dollars have been known to break apart from their underlying commodities for months, or even years at a time.

Correlations hold true generally, but there are times when they buck the norm. You want to be prepared for those times when they come. Don’t make the mistake of assuming that these com-dollars always dutifully track commodity prices.

This tells me that the commodity’s direction or strength should only be one aspect of our analysis when it comes to trading these commodity dollars and not the only thing on our radar when it comes to trading these Com-dollars.

So dodge that bullet and take a lesson from someone who’s traded these markets long enough to know that you need to assess a whole currency – not just one aspect of it.

Best Regards,
Sean