The Hindu Business Line : Dollar-commodity linkage turning tenuous

Nature of relationship
A weaker dollar reduces commodity prices for non-US consumers.
The correlations are lower for energy and agricultural commodities.
The negative breakdown in the dollar has prompted renewed investor interest towards gold

Dubai , Nov. 29

The sharp weakening of the dollar has once again focused attention on the nature of relationship between the currency and commodity prices.

There exists a significant long-term negative correlation between the US dollar and commodity prices; but varies significantly between commodity markets.

Supply effect

The correlations are strongest for base metals and precious metals. It reflects gold's quasi-monetary role.

For base metals, it reflects the presence of a negative supply effect - a weak dollar squeezes non-US producers' profits, and a positive demand effect - a weaker dollar reduces commodity prices for non-US consumers.

For energy and agricultural commodities, the correlations are lower, due to the additional influence of geopolitics and seasonal factors.

Recently, the negative correlation for silver and most base metals has moved up strongly and is reminiscent of the phase of strong correlations seen in 2004, according to Barclays Capital Research.

However, back then, a weak dollar was driven by very low interest rates which were also spurring strong demand for commodities.

This time around, the reason for the dollar/commodity price linkage is less clear-cut since dollar weakness is primarily a reflection of US growth concerns which are unlikely to benefit commodity demand, Barclays commented.

Tight fundamentals could well push prices of industrial metals higher and the dollar may continue to weaken; but the linkage is likely to be much more tenuous than it was in 2004, analysts said.

Gold

The recent negative breakdown in the dollar has prompted renewed investor interest towards gold, helping prices to recover from the lows reached in October.

According to forex experts, in the near term, there is limited scope for further upside in the euro/dollar from current levels which can put a lid on further gains for the yellow metal.

Also, physical buying remains vulnerable as further price rise can further slowdown sales.

Therefore, gold could trade more sideways at the current higher levels. A rise in crude prices could, however, benefit the metal.

Base metals

As for base metals, price volatility continues in the market amid concerns of a macroeconomic slowdown. Order levels in most market are reported healthy; but on the supply side there are issues. Labour action, strikes and falling inventories all point to constrained supplies.

While price risk is still to the upside in nickel and zinc, there are expectations copper could bounce back.

For refined production, the current raw material market is tight. Chinese import of refined copper picked up in October.

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