 Fx and the Commodities Boom
by Kevin Pendley
Commodity prices have been booming for several years now, led of course by the relentless upward press in the energy arena. In the last year, crude oil prices alone have doubled, and sticker shock at the gasoline pump threatens to cripple economic recovery in the United States before it really even takes hold.
The Commodity Research Bureau Index, which tracks price movement in a broad basket of some 19 commodities markets (including energy) and shot to all-time highs this week, is up 17% for the year, up nearly 52% from the 2007 bottom and has exploded 135% since the 2001 trough. And it's not just crude oil fueling the run in commodities. As huge population centers in Asia upgrade living standards, demand for everything from copper to gold to even food staples spikes higher. And it's not as if the massive population zones have finished the job yet.
The obvious play on the energy move has been to buy crude oil futures, and in fact, there is rampant jawboning among OPEC producers and politicians that speculators have gone wild in the energy feeding frenzy, helping to send prices well beyond supply and demand parameters. Although speculative bubbles can exaggerate price peaks and valleys, it is silly - and dangerous - to think that speculators are to blame for the rise in energy values. Until we develop alternative fuel sources, rising wealth and economic growth in developing nations such as China, India and other Far East locales will continue to power demand for physical commodities.
From a foreign exchange perspective, are there trades to be made that can capitalize on the boom in commodities? The quick answer is yes, but it can be a little more complicated than simply buying one currency product.
The first thing to do is to isolate out countries that are strong commodity producers versus those that tend to be much more aggressive commodity consumers. Right off the bat, big commodity producing countries that come to mind include: Canada, Australia, Brazil, Mexico, South Africa and Russia. In fact, Goldman Sachs expert research department says that a basket of the latter four countries have outperformed a basket of consumers like China, Taiwan, Korea, India and Turkey by 8% in just the last couple of months.
From a currency trading standpoint, I would pull out China for now because that currency rate is undervalued amid spectacular growth and is on a one-track trend higher against most of its major trading partners, which makes it an unattractive short in my mind against some of the obvious commodity FX longs to consider. The most liquid market to consider for the short end of the commodity trade concept is the yen, which trades directly with the Australian dollar in the interbank market. The Aussie/yen market has jumped 10% since March and is now testing key resistance on the charts near the 100 level. If it can pop through 100, it could set the wheels in motion for another 4% to 5% advance in the weeks to come. In fact, the Aussie dollar has been on a roll versus several major currency products, setting new multi-year highs against the British pound this week.
Another trade that makes sense is the dollar/real pair. "Real" as in the Brazilian currency. We'll go more into the details of the amazing Brazil demographics in a future column, but suffice to say, this is a great commodity producing country and their currency stands to gain amid growing worldwide demand for physical products.
The greenback has been sinking against the Brazilian real for the last several years, and the real has basically doubled in value versus the U.S. dollar since 2004. The market might look a little oversold, but shows no signs of reversing course. It's not unfathomable to think of the real approaching par against the dollar in the months to come.
To update last week's trade concepts, the euro took flight and stopped out our short euro/dollar trades this week with a modest profit, and closed out the short euro/yen trade with a slight loss. The short euro/Canada dollar trade is still holding a nice profit. Although the rally in the euro is impressive, I am still waiting for the right signals to re-enter short positions, which I'm sure we'll address in the weeks ahead.
FX COLUMN TRADE CONCEPT RECAP
DATE CONCEPT PRICE THEN/NOW PROFIT/LOSS COMMENT
4/24/08 Short euro/dollar entered @ 1.5682 +0.52% stopped out at 1.5600
5/01/08 Short euro/yen entered @ 161.50 +0.12% stopped out at 161.30
5/08/08 Short euro/Canada 1.5680/1.5475 +1.31% hold; stops at 1.5640
5/15/08 Short euro/yen entered @ 162.40 -0.36% stopped out at 163.01
Kevin Pendley has been involved in financial and commodity markets for two decades, including more than 15 years with Knight-Ridder Financial News/BridgeNews. In addition to his work at 4xAdviser.com Weekly, he is a contributor at SmallCapInvestor.com where he writes a weekly technical analysis column on the Russell 2000.
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