Perspective - The dollar and commodity prices

The dollar dropping forever is not a good thing. However, for now, it’s not altogether terrible. If nothing else, it’s helping US companies of all types and sizes do business overseas. Let’s look at some of the mechanics of what’s going on.

Whether a currency – anybody’s – is considered weak or strong is directly related to what return that currency provides compared with other currencies. So, since the prevailing interest rate here is, effectively, zero – the dollar is considered to be weak. Further, the dollar has a great influence on commodity prices since ALL commodities are priced in dollars.

We have the risk trade. Today, that means you sell (short) the dollar and buy commodities and companies in emerging markets. That’s done because with the dollar being weak, commodity prices keep rising and because the traders believe that the emerging markets are where the major growth will come from.

Then there’s something called the carry trade. This is a popular strategy in the foreign exchange markets. The traders buy the higher interest rate currencies while selling the ones with lower rates, i.e., the dollar.

Let’s consider a few specific commodities.

How about gold? According to Bill Gary, president of Commodity Information Systems Inc., “gold is particularly affected by the weakness of the dollar because it has always been viewed as a safe haven for catastrophes and depreciation of currencies.” Over time, it has provided a marginal return at best. Since it offers no dividends or interest, the only way you benefit is to “buy low, sell high.”

Oil is the prime example of how the dollar being weak has benefited commodity prices. There are still huge inventories globally and demand continues moderate, at best. The weak dollar and increasing demand from Asia and India can help keep prices high, even when the dollar strengthens.

Supply and demand is impacting soybeans more than the dollar. The crop has been a strong performer the last few months. However, huge yields are expected from both South America and the US next year. Even though that magic bean has many uses and Asian demand will likely remain high, seems that production looks bigger than demand.

Commodities are considered to be non-correlative to the stock market. In American, that means that, for the most part, if stocks are up, commods are down and vice versa, so it can be a great way to get your asset allocation in balance.

You can invest through stock in a commodity company, or one that has something to do with the production of a commodity, exchange traded funds or commodities (ETFs or ETCs), individual commodity futures, commodity mutual funds and managed futures funds. All have varying degrees of risk and investment requirements.

The biggest risk factor for all commodities over the next few months is the reallocation of money back into the dollar. That can occur for two reasons. First, if there is a major correction in the stock market, investors will look for safety in the dollar and that would be a caveat for the whole complex. I don’t think that’s hardly likely. The other is that the Fed actually increases our interest rates. That doesn’t look likely now until late 2010 at the earliest.

The bottom line…find what you’re most comfortable doing. Do your homework and understand that fluctuation can have a whole new meaning when it comes to commodity type investments.