The Effect of Currency Prices on Commodity Prices and Stocks
Essentially, the effect of currency fluctuations on the domestic market will depend on the self sufficiency of the country in question. When a nation is a net importer of foreign goods, a depreciation in the domestic currency will lead to less demand for goods as the domestic currency loses its purchasing power, and so depending on the volume of consumption that is impaired, may cause weakness in commodity markets. In the same scenario when domestic corporations are net importers of raw materials or manufactured goods, their profitability is impaired when their expenses rise and so a currency devaluation will lead to weakness in the stock market.
Further, commodity prices of exports will also come under pressure as exporters seek to take advantage of the lower currency and increase supply in order to benefit from what is effectively a higher sale price for their goods.
Given the breadth of a global economy, the connection between one commodity process in one country and currency prices may not be as direct as the above discussion alludes toward. Some countries suffer weakness in asset prices due to their connection with another country whose currency or purchasing power has been impaired due to devaluation. The net effect of a lower domestic currency is that demand is lowered for imports, and this in turn will affect that country’s trading partners, whose equity and commodity markets too will experience weakness.
When a domestic currency is strong, again, depending on the countries dependency on imports, commodity prices may well remain firm as demand is allowed satisfaction derived from sustainable purchasing power in the international market. Still, if the country is not reliant on imports to any large extent, a strong currency may dissuade its exporters from full production due to the effectively lower price they receive for their exports.
If corporation’s costs are reduced due to a strong domestic currency and their reliance on component imports, their profitability will be favorably reflected in the stock market.
The United States however, is in an enviable position in that it is a reserve currency with the other industrial nations of the world forming the periphery around it. It therefore has a number of privileges, not the least of which is of having globally traded commodities denominated in US dollars. In that respect, US exporters will not necessarily be affected by currency fluctuations in the US dollar, as they will ordinarily be paid in the same. Still, while there is some advantage to be enjoyed, the principles of marginal utility will see demand from foreign commodity markets weaken when the US dollar experiences strength. The lack of revenue from this contingency will certainly have bearing upon US corporations and subsequently, the stock market.
The risk to the US in its extensive import market is where the greatest advantage lies however, while demand in the US will remain strong due to imports being paid for in US dollars in any case, other countries will need to convert their US dollar revenue into their domestic currency and so if the US dollar is particularly strong, this will dissuade foreign exporters from full production at what is to them a decrease in sale price.
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Tags: currencies commodities options
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