There’s a strong relationship between equities, bonds, currencies and commodities. It happens in a cycle: as the dollar gains, commodity prices fall, bonds go up while yields decline, and, finally, equities experience an increase. Not everything occurs at once, and lag is a natural part of the equation. But cross-connections can be difficult to predict and understand – such as how interest rates correlate with commodity prices.
The Global Economy's Influence
The resurgence of commodities is dependent on macroeconomic factors. Goods and materials like wheat and oil are necessary for continued growth across the globe. But not everything happens in a neat and predictable manner. The collapse of the Chinese economy was devastating for commodities. As the world leader in manufacturing, China was responsible for importing commodities like steel, oil, iron, copper and numerous other goods to meet demands. Without that demand, commodity prices have fallen.
In a global marketplace, all assets are connected. Even without China’s demand for commodity goods, there are other factors at play. There’s a very strong reverse correlation between the U.S. dollar and commodity prices. This happens because the U.S. dollar is the globally recognized currency upon which trade is based. A weak dollar might mean higher exports for the U.S. where foreign countries’ currencies go further, but it also means that commodities will come at a premium.
A simple explanation for this relationship can be explained by looking at gold. Gold is seen as a safe-haven asset that holds its value at a steady rate regardless of foreign exchange rates. If the dollar is weak, then investors flee to more reliable assets, like gold and other commodities, in order to maintain value.
Taking into Account Current Events
Generally, commodities do well when the dollar is weak and interest rates are low. The extended environment of low interest rates that we’ve seen over the past few years should have resulted in a weak dollar and high commodity values. However, that hasn’t been the case. The U.S. dollar has remained stubbornly high despite low interest rates because it’s been seen as a safe-haven asset in a time of global uncertainty. Given the collapse of Chinese demand, which supported commodity values for the past decade or so, it’s no surprise that the dollar has been the more highly valued asset.
Higher interest rates are usually a death knell for commodities as other higher earning assets become more attractive. But with a global economy in flux and the U.S. dollar struggling to hold on to its reign as a dominant asset class, commodities could be poised for a recovery over the next year.
Commodities appear to have bottomed, and an environment of rising rates might not be a factor right now. As interest rates rise, the dollar might not receive any extra support. The global economy is still trying to adapt to a world without Chinese commodity demand and there is plenty of room for other economies to take over the mantle. Europe is well on its way to recovery, and India, despite some setbacks this quarter, is still expected to grow at around 5% this year, and will increase to 6% in 2016. Even though commodities are at a low point, higher interest rates right now might have to be valued as a relative increase given the state of the global economy.
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