You have probably noticed that news about oil has been dominating the market throughout 2022.
So I’ll use this opportunity to explain about the highly influential and historically rich correlation between different markets.
US and OIL
During the Nixon led regime in 1974, the U.S. Government entered into a series of bilateral agreements with the largest exporter of Oil – Saudi Arabia.
The U.S. economy was largely built around the need and use of Oil, so these arrangements had a series of profound benefits for the USD.
USD became known as the petrodollar because:
- USD was received by an oil producer in exchange for selling Oil; and
- those USD’s were then deposited into Western Banks.
This arrangement sounds simple, but it was actually quite complex.
Because these agreements included the U.S. offering military protection for Saudi Arabia’s oil fields and the supply of weapons which perhaps most importantly, meant guaranteed protection.
The terms of this agreement included Saudi’s promise that they would:
- price all of their oil sales in USD’s only for their oil exports; but
- would be open to investing their surplus oil proceeds in U.S. debt securities.
The whole deal had a profound and immediate impact.
By 1975, all OPEC members had agreed to price their Oil in USD and to hold their surplus oil proceeds in U.S. Government debt securities – in exchange for U.S. protection, weapons and stability of USD investments.
It is also important to note that based on its historical relationship, when oil prices rise, the USD/CAD falls and vice versa: when the price of oil goes down, the USD/CAD rises.
The Canadian economy is highly dependent on its exports, and majority of its exports go to the United States. For this reason, the USD/CAD can be greatly affected by how American consumers react to changes in oil prices.
When U.S. demand increases, the price of oil rises and the price of the USD/CAD goes down.
When the U.S. demand falls, the price of oil decreases and the USD/CAD price rises.
Establishing the Petrodollar System
The Petrodollar deal provided immediate benefit to the United States because of:
- increased global demand for USD
- increased global demand for U.S. debt securities
- gave the U.S. the internationally unique ability to buy Oil with a currency it could simply print infinitely.
Today, USD’s can be bought the moment they are needed to settle oil trades.
Or settlement can simply be done in any other agreed currency, at the currency’s current USD exchange rate.
Since Oil is priced in dollars, there is a strong inverse correlation.
JPY Correlation With Equities
Basically, when its risk-on environment:
- Commodities prices tend to increase.
- Traders go long AUD due to that factor.
- When commodities prices go up, Stock Markets go up
- There is a demand for positive swaps on AUD pairs currently as opposed to JPY.
When it’s a risk-off environment, usually the opposite occurs. As a result, the JPY appreciates as foreign flows from Japan are repatriated back to their local currency.
Best correlation with JPY pairs, are USDJPY vs Nikkei and AUD/JPY vs ASX200 market. Japanese can get cheap credit, so they invest overseas heavily.
When it’s risky, they bring the money back creating demand for Yen. When its bullish Equities, they pump their money overseas, which means they sell Yen and buy foreign currency. Traders might want to short Nikkei if Yen appreciates overnight.
AUD Correlation With Gold
The AUD has a high correlation to gold due to Australia’s extensive gold mining operations. As gold prices fluctuate, this increases or decreases the number of funds transferred into AUD to make purchases of the metal. These transfers essentially change demand for the currency and can directly cause changes in the AUDUSD currency pair as well.
Whenever you trade, you need to pay attention to these Inter Market correlations. It will make your trading even better!
Cheers and safe trading,
Cheers and safe trading,