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Resources and commodities ride a dollar price carousel

The USA dollar dipped below 1.20 per euro in the first week of June, for the first time since March 2006. The steep drop of 16.8% from the beginning of the year, is ascribed to renewed troubles in the Euro Zone.
Public debt problems in several European countries sent jitters through markets and left a mark on commodity prices. The price of gold are setting record highs above $1250 due to increased economic uncertainty, while the value of many other commodities, including oil, traded at lower prices compared to recent peaks.

Low euro keeps prices down

Commodity prices would have rebounded quicker if it was not for economic problems in Europe as well as the steep depreciation in the euro. Higher growth, financial stability and a quicker recovery result in higher demand for commodities, but also in a stable currency.
Since commodities are priced in USA dollar terms, dollar depreciation (weakening) causes prices to increase, and vice versa. It is relatively cheaper to buy commodities in other currencies if the dollar depreciated.

Correlation test

A correlation coefficient is an easy way to test co-movement between variables. USA dollar-euro exchange rates and selected commodities in monthly data reveal a correlation. Commodity prices generally move closely together, but the USA dollar exchange rate has a clear impact on prices.
Correlation is rated between strong (1) and weak (0). A time lag of zero indicates the strongest correlation in most cases. Weaker correlations exist in nickel, uranium and zinc, where the best correlation in recent months is longer than a month.

Euro peg problems

The natural consequence for an economy with a free floating currency and underlying economic problems, would be depreciation of its exchange rate.
This is one of the contributing problems in the European Monetary Area, where member countries are pegged to the euro, but economic performances differ. Weaker economies with biggest sovereign debt problems ca not let their exchange rate depreciate, since they are pegged. The only outcome is a weaker euro.
As a result of current depreciation of euro against dollar and other main trading partners, and EU economic potential, euro area countries will receive higher export earnings in future.
If confidence is re-established, new investments will be attracted, to lead to growth and eventually euro appreciation, and further increases in commodity prices.
The irony is that the USA, given their debt levels, would also prefer a weaker currency to boost exports and protect their domestic market.

* Dr Johannes Jordaan is senior economist at Economic Trend SA, visit www.economictrendsa.co.za

 

 

 

 

 

 

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