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Strong Dollar Drives Commodities Losses

David Becker
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Strong Dollar Drives Commodities Losses

One of the most consistent inter-market relationships is that the dollar and commodities trend in opposite directions. When comparing the U.S. Dollar Index to the CRB Index of nineteen commodities since 2000, the correlation is negative. The major upturn in commodities started in 2002 just as the USD was starting a major descent. The second major turning point came in mid-2008 when a major peak in commodities coincided with a dollar bottom. 2008 marked the highpoint for commodities and the low point for the dollar.

The Correlation Coefficient between the two markets has been negative throughout the entire period, with a current negative correlation of -.80. This means that 80% of the time the dollar and commodities move in opposite directions. One of the positive side-effects of lower commodities is that it reduces inflation expectations, which reduces the need for the Fed to tighten monetary policy too fast, and also reduces upward pressure on bond yields. All of those factors are positive for stocks and U.S. stock in particular.

Another side effect of a stronger dollar is that it favors U.S. over foreign stocks. The correlation between the two is clear. Between 2002 and 2008,as the dollar fell, the falling ratio showed U.S. stocks under-performing foreign stocks. During those six years, the foreign stock index rose 75% versus an S&P 500 gain of 12%. Since the middle of 2008,when the dollar bottomed, U.S. stocks have outpaced foreign stocks. An S&P 500 gain of 55% since 2008 compares with a -2.5% loss in the MSWorld Index. A higher dollar could very well widen the margin of U.S. over foreign stocks. A falling dollar also appears to favor emerging markets more than developed markets, while a stronger dollar appears to favor developed over emerging markets. One reason why a stronger dollar favors U.S. stocks is that it suggests higher interest rates and a stronger economy. A strong currency also attracts foreign capital to U.S. markets.

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