In the Forex market, the values of currencies move up and down as a result of many factors, including — but not limited to — supply and demand, interest rates, economic growth and political conditions. Because of this, the more dependent a country is on a large domestic industry like oil, the stronger the correlation will be between a national currency and its industry’s commodity prices.
In general, there is no uniform rule for determining what commodities a given currency will be correlated with and how strong that correlation will be. However, some currencies provide good examples of commodity-Forex relationships — and oil, in particular is one of the most powerful commodities when it comes to influencing the value of currencies associate with its production.
Here are 3 tips about oil prices and their effect on Forex trading that all traders need to know:
Oil Prices Affect Currency Values
For an example of a currency that is directly connected to the price of oil, consider the Canadian dollar. When the price of oil goes up — usually because of worldwide demand and the limitations put on oil production by OPEC nations — the Canadian dollar tends to become worth more when based against other currencies. Canada is a net oil exporter, so when oil prices are high, Canada often receives greater profits from its exports, which gives the CAD a boost on the Forex market. Therefore, when trading pairs involving CAD (such as USD/CAD or CAD/USD, it is wise to have an understanding of the current forces working on oil prices.
Recent times have seen oil prices come down to the lowest they have been in years — under $50 a barrel, which has had a huge impact on countries maintaining large oil resources, including Norway and, of course, Canada. A recent headline on OilPrice.com says it clearly, “Conflicting News Keeps Oil Prices Down,” and wise Forex investors always keep an eye on major nation commodities before committing to their trades.
One other quick example to explain the connection between commodities and currency value: The Australian dollar (AUD) is positively correlated with gold. Because Australia is one of the world’s biggest gold producers, its dollar tends to move in unison with price changes in gold bullion. This means that when world gold prices rise significantly, the Australian dollar will also be expected to appreciate against other major currencies.
Oil Prices Affect Other Aspects of the Economy
Along with the direct result changes in oil prices have on a country’s currency value, it is important to take into consideration the other subsequent effects that happen when oil prices rise or fall. Before the lowering of oil prices, cities in Canada such as Calgary had huge construction and housing booms, as workers poured into the city to take oil-related jobs and make money from the growing business. However, the change in oil prices from 2014 to 2015 had devastating consequences for Calgary’s housing market, as seen in this article from the time.
Similar events are currently happening in Norway, and while USD/NOK is perhaps not the most traded pair, investors who are interested in trading the Krone would be advised to stay on top of articles like this, which show that recently housing prices in Norway have fallen more than expected, thanks to the price of oil driving down the economy.
Understand Why the Price of Oil Moves
If you are trading currencies that are affected by oil prices, it would be a good move to have an understanding about the forces that drive the price both up and down. Crude oil prices move largely because of the perceptions of supply and demand affected by worldwide output, as well as the overall global economic prosperity. In the commodities market, an oversupply of oil and shrinking demand encourages commodities traders to sell crude oil markets to lower prices. Rising demand (and declining production) encourage traders to bid crude oil to higher prices.
Within the past decade, we have seen everything from the surge of crude oil to $145.81 per barrel in April 2008 to downtrends in August 2015 bringing the price down to $37.75 per barrel.
Where oil goes, currency values will follow, and smart Forex traders will always monitor oil prices to help them determine the trends that could follow immediately from how the world prices its oil.