Commodity prices could reverse as the US dollar rally loses steam

London (Nov 8)  When the dollar strengthens against other major currencies, the prices of commodities typically drop. When the value of the dollar weakens against other major currencies, the prices of commodities generally move higher.

There are many reasons why the value of the dollar has an impact on commodity prices. The main one is that commodities are priced in dollars. When the value of the dollar drops, it will take more dollars to buy commodities.

Another reason is that commodities are traded around the world. Foreign buyers will purchase our commodities – corn, soybeans, wheat, oil, etc. – with dollars. When the value of the dollar drops, they will have more buying power and simple economics tells us that demand typically increases as prices drop.

Commodity traders often keep a close eye on the value of the dollar. An easy way to monitor the dollar is to watch the price quotes on the UUP. It is an ETF that tracks the US dollar index – an index of how the dollar is valued against a group of other major currencies around the world. The price of the index is traded like any other futures contract and you can get quotes throughout the day.

A recent surge in the value of the UUP has been putting downside pressure on the value of DBC.

Take a look at the chart I’ve included, showing UUP and DBC side by side:

When comparing the charts of these 2 markets to one another, we can see that the US dollar (bottom frame) has been in a downtrend since July, and when the dollar has surged or dropped quickly, it has caused a sharp move in the price of commodities (DBC is in the top frame). In late August, when the US dollar had a bear rally, DBC dropped. In September, when the dollar dropped, DBC rallied. Then the US dollar consolidated for about a month around the 21.50-21.70 range, and then suddenly sold down to 21.32, but at that point it bottomed. It then began a bear rally up to the 21.70 level, and that inverse correlation I’ve been talking about played out once again, as DBC fell in kind.

But both the UUP and DBC are now at key inflection points on their charts. The US dollar is hitting resistance at that 21.70 level, and the DBC is forming a makeshift morning star reversal pattern right near the 25.20 level where there is a swing low support level from August. With the dollar likely to fall back down and resume its predominant downtrend, commodities can rally off support here.