Source of wealth affects nation's currency value

Source of wealth affects nation's currency value

CURRENCY MATTERS: Kathy Lien, GFT research director December 10, 2008
Article from: The Australian
OVER the past four weeks, we have discussed the three primary things that move currency markets -- politics, economics and monetary policy.
However, as you learn more about investing and trading currencies, you will quickly realise that the foreign exchange market is also intimately tied with commodity and equity markets.
Knowing this can help you predict movements in currencies or offer additional ideas for diversification.
When trading currencies, you are taking a view on a country. Therefore, the source of that country's wealth has a direct impact on its growth prospects and, by extension, the value of its currency.
For example, the lifeblood of Australia is gold and coal. As the world's third-largest producer of gold and fourth-largest producer of coal, the values of these commodities have a direct impact on the value of the Australian dollar.
When gold prices hit a record high above $1000 an ounce, the Australian dollar hit a 25-year high. Now that the price of gold has plunged 20 per cent, the value of the Australian dollar has declined 30 per cent.
Canada on the other hand has the second-largest oil reserves in the world, making the Canadian dollar sensitive to the price of oil.
Since this past northern summer, oil prices have plunged approximately 65 per cent from its record high of $US147.27 barrel.
During that same period, the Canadian dollar has fallen more than 20 per cent.
Similarly, when oil prices were soaring late last year, the Canadian dollar hit a record high, with one Canadian dollar worth more than one US dollar.
For countries that have well-developed capital markets, equities can also have a substantial impact on the value of their currencies.
Over the past few years, we have seen a positive correlation between the S&P 500 and US dollar/Japanese yen.
When US equities rally, the dollar has tended to rally against the yen. The same is true for the FTSE in Britain.
Generally speaking, when the FTSE sells off, we also see weakness in the British pound.
We must understand, however, that although these correlations are historically valid, like all things, they are not accurate 100 per cent of the time.
This is especially true if there are big surprises in politics, economic data or monetary policy.
However, these correlations generally have stood the test of time.
In fact, certain currency brokers allow you to track the price action of instruments such as the Australian dollar/US dollar and gold on the same chart so that you can see whether the correlation is holding on a day-to-day or even minute-to-minute basis.

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