Commodity Currencies: What They Are & How to Trade Them

What is a "commodity currency?"

Commodity currencies are a unique and significant part of the foreign exchange (forex) market. These are currencies from countries whose economies heavily depend on the export of natural resources—such as oil, metals, or agricultural products. For traders and investors, commodity currencies provide a way to gain exposure to fluctuations in these commodity markets without directly trading the underlying assets. Currencies like the Canadian dollar (CAD), the Australian dollar (AUD), and the Russian ruble (RUB) are prime examples, as they are closely tied to the prices of the commodities exported by their respective countries.

Due to their sensitivity to commodity price movements, many forex market participants use these currencies as a way to express their views on the direction of commodity markets. For instance, a trader anticipating a rise in oil prices might choose to trade the Canadian dollar (USD/CAD), as Canada's economy is closely linked to oil exports. By trading these currencies, market participants can take advantage of the movements in commodity prices while benefiting from the liquidity of the forex market.

The importance of currency pairs in commodity-related FX trades

When trading the foreign exchange market, understanding the importance of currency pairs is crucial. Currency pairs are the fundamental units of foreign exchange trading, and this concept also applies to commodity currencies. In general, a high level of liquidity is usually preferred, which is why forex traders typically gravitate toward the highest liquidity currency pairs.

This approach extends to the "commodity currencies." For example, the Canadian dollar (CAD) is often traded against the U.S. dollar (USD) because Canada's economy is heavily tied to oil exports, and oil is priced in U.S. dollars. Similarly, the Australian dollar (AUD) and the New Zealand dollar (NZD) are frequently traded against the U.S. dollar due to their links with commodities like gold and agricultural products.

In the hypothetical currency pair "ABC/DEF," the first currency (ABC) is the "base currency," and the second currency (DEF) is the "quote currency." The exchange rate tells you how much of the quote currency is required to purchase one unit of the base currency. For instance, if the EUR/USD exchange rate is 1.08, that means 1.08 U.S. dollars (the quote currency) are required to buy a single euro (the base currency). These pairs work the same way for commodity currencies, the only important thing to note is that certain pairs tend to be especially popular with a given commodity currency.

Looking at an example, imagine a trader wants to take advantage of a rally in the oil market. This trader might elect to trade the USD/CAD pair, because the value of the Canadian dollar often rises when oil prices increase. And this tends to be one of the most commonly traded currency pairs for oil-focused trades. Of late, the Swiss Franc (CHF) has emerged as another oil-focused currency, and is typically paired with the U.S. dollar (USD/CHF).

High-profile commodity currencies

Some of the best-known commodity currencies are highlighted below, but it's crucial to be aware that not all of them offer robust levels of liquidity. Certain commodity-linked currencies exhibit lower trading volumes, which can result in wider spreads and increased price volatility. For investors and traders who are new to the forex market, these less liquid pairs may therefore introduce additional risks. As such, investors and traders new to the forex universe may want to avoid low-liquidity currency pairs, at least until they are comfortable managing the risks associated with such positions. Ultimately, gaining experience and understanding the nuances of these markets is key to navigating them successfully.

Canadian Dollar (CAD)

• Description: The Canadian dollar is one of the most widely traded commodity currencies, primarily influenced by the country's vast oil reserves and natural resources. Canada is one of the largest oil producers in the world, particularly in oil sands.
• Why it's popular: The CAD is highly sensitive to fluctuations in oil prices because of Canada's reliance on oil exports. When oil prices rise, the Canadian economy benefits from increased oil revenue, strengthening the Canadian dollar. Oil traders and FX participants use the CAD as a proxy for exposure to oil price movements.
• Most common currency pair: USD/CAD (U.S. Dollar/Canadian Dollar)

Australian Dollar (AUD)

• Description: The Australian dollar is another key commodity currency, largely influenced by Australia's role as a major exporter of minerals, especially gold, iron ore, and coal.
• Why it's popular: Like the CAD, the AUD is often used to express opinions on global commodity demand. The AUD is positively correlated with commodity prices—especially gold—so when the price of these metals rises, the AUD tends to strengthen. This makes the AUD a popular choice for traders looking to gain exposure to the global commodity market.
• Most common currency pair: AUD/USD (Australian dollar/U.S. Dollar)

Swiss Franc (CHF)

• Description: While traditionally a safe-haven currency, the Swiss franc has recently become more correlated with oil prices, primarily due to Switzerland's significant role in global commodity trading and financial markets.
• Why it's popular: The Swiss franc often moves with oil prices due to Switzerland's position as a global trading hub, with many oil transactions processed through Swiss institutions. Additionally, the CHF is seen as a safe-haven currency during periods of global uncertainty, which can align with oil market dynamics during risk-off environments.
• Most common currency pair: USD/CHF (U.S. Dollar/Swiss Franc)

New Zealand Dollar (NZD)

• Description: The New Zealand dollar is influenced by the country's agricultural exports, particularly dairy products, and its natural resources.
• Why it's popular: The NZD tends to track the price of commodities like dairy, meat, and wool, as these exports are crucial to the country's economy. Traders often use the NZD to reflect the global demand for these agricultural products and the economic performance of New Zealand's export sector.
• Most common currency pair: NZD/USD (New Zealand Dollar/U.S. Dollar)

Norwegian Krone (NOK)

• Description: The Norwegian krone is heavily linked to oil prices, as Norway is one of Europe's largest oil exporters.
• Why it's popular: Similar to the CAD, the NOK is sensitive to fluctuations in oil prices. A rise in oil prices typically leads to a stronger krone, making it a useful currency for traders seeking exposure to the energy sector. Norway's robust sovereign wealth fund, backed by oil revenues, further reinforces the currency's importance in commodity trading.
• Most common currency pair: USD/NOK (U.S. Dollar/Norwegian Krone)

Russian Ruble (RUB)

• Description: Russia, as one of the largest global exporters of oil and natural gas, has a currency strongly influenced by energy prices, especially oil.
• Why it's popular: The ruble's value is closely tied to global energy markets. When oil prices rise, Russia's economy benefits from increased revenues, which strengthens the ruble. This makes the ruble a popular choice for trading in conjunction with oil and gas markets, despite its higher volatility compared to other commodity currencies. Please note, the ruble isn't typically available for trading in the U.S. market.
• Most common currency pair: USD/RUB (U.S. Dollar/Russian Ruble)

How to trade commodity currencies

Commodity currencies can be traded using many of the same strategies as other currency pairs in the foreign exchange market. However, traders and investors should be aware of the unique factors that influence commodity currencies, as their price movements are often closely tied to the performance of the underlying commodities, such as oil, metals, or agricultural products. Unlike traditional currencies, commodity currencies can experience pronounced fluctuations due to changes in commodity prices, making it crucial to understand these dynamics when engaging in forex trading.

That said, commodity currencies do offer a distinct avenue for gaining exposure to commodity markets without directly trading futures contracts or equities. For instance, a trader with a bullish outlook on oil might consider going long on the Canadian dollar (CAD) or Swiss franc (CHF). That's because these currencies are often positively correlated with oil prices—when oil rises, the economies of oil-exporting nations like Canada and Switzerland generally benefit, which in turn supports their currencies. This provides traders with a more accessible way to tap into commodity price movements through the forex market.

It's important to note, however, that trading commodity currencies doesn't guarantee a profit. While these currencies often move in tandem with the price of the underlying commodity, other market forces can offset this relationship. For example, if the Eurozone were facing economic weakness or recession, the value of the euro might decline, potentially diminishing the positive impact that rising oil prices could have on currencies like the Swiss franc.

Therefore, investors and traders must remain mindful of the many factors that can influence currency markets. It's essential to consider not only the movements in the commodity markets, but also the broader economic landscape when implementing commodities-focused forex strategies. While commodity currencies provide an interesting way to express views on commodity trends, successfully trading them requires a thorough understanding of the complex, interconnected forces that drive their value.

Benefits and risks of trading commodity currencies

Trading commodity currencies offers a distinctive set of benefits and risks compared to more traditional currency trading. Like any forex strategy, it presents the potential for profit, but also carries the risk of loss—particularly due to the factors that drive these currencies. One of the key advantages of trading commodity currencies is their strong correlation with the underlying commodity markets. For example, when oil prices rise, the Canadian dollar (CAD) tends to appreciate, as Canada is a major oil exporter. This correlation provides traders with a unique opportunity to gain indirect exposure to commodity price movements without having to trade futures or stocks tied to the commodity itself.

However, while this correlation can offer a clear trading signal, it also introduces a level of risk. Sudden or unexpected shifts in the commodity market can trigger equally sudden and volatile moves in the currency market. For instance, a sharp drop in oil prices can lead to a significant depreciation of the Canadian dollar, even if broader market conditions or economic fundamentals don't justify such a dramatic change. Similarly, when a currency closely tied to a commodity experiences a reversal, the resulting shift can move quickly and against the trader's position, magnifying the risk.

Moreover, trading commodity currencies requires an understanding of both the foreign exchange and the relevant commodity markets. While commodity currencies may appear to be an attractive way to trade commodity price movements, they can also be influenced by broader macroeconomic factors, such as global economic trends, political events, and central bank policies. This means that the success of a commodity currency trade depends not just on commodity price movements, but also on the wider economic and financial landscape. Consequently, traders need to carefully assess the risks posed by these external factors and be prepared to adjust their strategies as market conditions evolve.

Ultimately, while commodity currencies provide an alternative approach to commodity trading, they come with their own set of challenges and complexities that require a well-rounded, flexible approach. And as with any investment or trading strategy, investors and traders should also develop a solid risk management plan when trading commodity currencies, and strictly adhere to it.

Commodity currencies key takeaways

• Commodity currencies are currencies of countries that rely heavily on the export of natural resources, such as oil, metals, and agricultural products.
• Commodity currencies often move in sync with the prices of the commodities they are tied to, as fluctuations in commodity prices impact the nation's economic health and trade balance. But these relationships are fluid, and change over time.
• The Canadian dollar (CAD) is a prime example of a commodity currency, as it is heavily influenced by oil prices due to Canada's large oil export market.
• The Swiss franc (CHF) is another commodity currency, and at times exhibits a stronger correlation with the oil market than even the Canadian dollar. But again, this relationship is fluid, and ever-changing.
• Commodity currencies are closely tied to commodity markets, offering a way to gain exposure to commodity price movements without directly trading futures or equities.
• When trading commodity currencies, investors and traders should account for the unique factors influencing these currencies, such as fluctuations in commodity prices, geopolitical developments, and overarching economic trends.
• While commodity currencies can offer an indirect way to trade commodity price movements, they also come with added complexities. Sudden, unexpected price shifts in the commodity market can result in equally volatile moves in the currency market.
• The evolving dynamics of commodity currencies mean that correlations can change over time. Traders must therefore be adaptable, and track these changes in order to adjust their trading approaches.
• Trading commodity currencies requires not only an understanding of the currency market but also the ability to analyze the related commodity markets. As the relationships in these markets shift, traders and investors must stay vigilant and adjust their outlooks accordingly.
• As with any investment or trading strategy, investors and traders should develop a solid risk management plan when trading commodity currencies and strictly adhere to it.