US DOLLAR GOING UP MAKES COMMODITIES GOES DOWN – WHY?

  Commodities are priced in US dollars (even the Europeans buy a barrel of oil in US dollars). So, WHEN THE US DOLLAR GOES UP IN PRICE, THEN COMMODITIES GO DOWN IN PRICE (all other things being equal). Does this concept make sense to you? If not, read on… Assume 3 people (a Brit, a Frenchman and an American) are trying to buy a barrel of oil. A barrel of oil costs $43.00. For the American, the cost is straight-forward: it’s $43.00. For the Brit, because he operates his business in pound sterling, the oil costs £28.00 (due to the exchange rate) and for the Frenchman, the oil costs €40.00. But suddenly, the US dollar appreciates by 10% versus the other currencies. The American doesn’t really care: he is still prepared to pay $43.00 for the barrel – nothing has changed for him. But the Brit can only afford to pay £28.00, which, because of the new exchange rate, is now worth only $38.70. The Frenchman is in the same position: he can only afford to pay €40 for the barrel of oil, which now equates to $38.70. There are no other buyers at the moment because everyone else has already bought enough oil for the time being (e.g. demand is constant). So the oil seller is forced to drop his price to meet what the Brit and the Frenchman are prepared to pay. Nothing has really changed: the Brit and Frenchman still bought 1 barrel of oil at the same cost to them (in terms of their own currency), but the price of the oil went down. And it went down solely because the value of the US dollar went up. While this is obviously a simplified example, this is essentially what happens on a large scale. Replace “Brit” and “Frenchman” with the UK economy and the European economy. Add in the Chinese, Japanese, Africans and everyone else (all of whom think of the cost of oil in their own currencies) and you get the above example occurring on a much bigger scale. That’s why when the US dollar goes up in value (and all other factors – like demand – remain constant), the price of oil goes down. Does that make sense? If you have any comments or questions, leave a post below and we’ll be happy to help. November 2015. Finimize.com publishes a daily financial news email. It’s easy-to-understand, takes 3 minutes to read and is totally FREE. You can sign up here.

 

Commodities are priced in US dollars (even the Europeans buy a barrel of oil in US dollars). So, WHEN THE US DOLLAR GOES UP IN PRICE, THEN COMMODITIES GO DOWN IN PRICE (all other things being equal). Does this concept make sense to you? If not, read on…

Assume 3 people (a Brit, a Frenchman and an American) are trying to buy a barrel of oil. A barrel of oil costs $43.00. For the American, the cost is straight-forward: it’s $43.00. For the Brit, because he operates his business in pound sterling, the oil costs £28.00 (due to the exchange rate) and for the Frenchman, the oil costs €40.00.

But suddenly, the US dollar appreciates by 10% versus the other currencies. The American doesn’t really care: he is still prepared to pay $43.00 for the barrel – nothing has changed for him. But the Brit can only afford to pay £28.00, which, because of the new exchange rate, is now worth only $38.70. The Frenchman is in the same position: he can only afford to pay €40 for the barrel of oil, which now equates to $38.70.

There are no other buyers at the moment because everyone else has already bought enough oil for the time being (e.g. demand is constant). So the oil seller is forced to drop his price to meet what the Brit and the Frenchman are prepared to pay. Nothing has really changed: the Brit and Frenchman still bought 1 barrel of oil at the same cost to them (in terms of their own currency), but the price of the oil went down. And it went down solely because the value of the US dollar went up.

While this is obviously a simplified example, this is essentially what happens on a large scale. Replace “Brit” and “Frenchman” with the UK economy and the European economy. Add in the Chinese, Japanese, Africans and everyone else (all of whom think of the cost of oil in their own currencies) and you get the above example occurring on a much bigger scale. That’s why when the US dollar goes up in value (and all other factors – like demand – remain constant), the price of oil goes down.

Does that make sense? If you have any comments or questions, leave a post below and we’ll be happy to help.

November 2015.

Finimize.com publishes a daily financial news email. It’s easy-to-understand, takes 3 minutes to read and is totally FREE. You can sign up here.

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maktt

What this also tells you is that the US isn’t buying much oil on the international market, compared to other economies, otherwise the price would rise, to some extent, for other buyers on the international market.

rpfeynman

The US is importing half the amount of oil it uses. That is about 10 million barrels per day. So to say it isn’t buying much on the international market is just plain wrong.

Finimize

I think it’s important to remember that, in the above example, all factors remain constant except the increase in the value of the US dollar versus the other currencies. So whether the US is buying much oil or not isn’t that relevant to the explanation. If the US were to buy MORE oil, then yes, of course, the oil price would go up. And I think Maktt’s point is that when the price of oil declines, it should generate more demand from Americans for oil which would push the oil price back up. But when US demand doesn’t increase due… Read more »

maktt

That was my point, and you’re right on the first point as well. I checked the US EIA’s data and although the US’s share of the top 20 importers has increased from 31.7% in 2006 to 34.57% in 2013, the total imports for the top 20 (not necessarily the same countries in both data sets) has dropped by a large 41.87%. As you say this has led to a very strong downward pressure on oil prices which in turn means that negative correlation of price in dollars to dollar value has more effect than upward price elasticity of concentrated demand.… Read more »

4thaugust1932

Americans can PRINT dollars to buy OPEC Oil;
Rest have to EARN dollars to buy OPEC Oil;
https://en.wikipedia.org/wiki/Petrocurrency#Currencies_used_to_trade_oil

John

Hi there – thanks for the explanation, I have a quick question please… in this example, would this also mean that the American would therefore end up paying the $38.70 or would he/she still pay the $43 while the French & Brit pay $38.70? Thanks!

finimize

Well, everyone would still need to pay $43.00. But, in order to get the $43, the Brits and French would have to pay more in terms of their own currency. The Brit would have to pay £30.80 and the Frenchman €44, which is of course higher than before the US dollar increased 10%. And so, as the price goes up for everyone except the American, demand goes down. And therefore the price of oil declines. Does that make sense?

Eugene

Hi Finimize, so does this mean everyone else would not lose as the oil price will be corrected downwards, but the American will gain as he is now paying less in terms of US dollars?

finimize

That could be the case, if the oil price (in $) fell and the cost of oil for others (in their respective currencies) doesn’t change. Of course, oil might not fall as much as the other currencies have fallen – and so it could still be more expensive for non-Americans. The main point is that oil (if the price doesn’t move) becomes more expensive for all nonAmericans when the US dollar strengthens versus other currencies. Since, all else being equal, demand goes down when price goes up, demand for oil goes down – and that hurts the $-denominated price. Does… Read more »

This seems pretty much straight forward. Today is 11/29/16 and I’m watching the @DX down, AND all commodities are down. metals, soft goods, grains, energy. Everything is down with the dollar going down as well. The only thing up today is the pound and the euro. I can’t find anything explaining this. Any ideas?

finimize

Hi Domenic – making sense of moves in a single day isn’t always possible! For example, commodity prices have recently been driven by Chinese buying. The dollar has been on a strong run, recently hit a 14-year high and is hitting strong technical resistance at this level (versus other major currencies). So it’s conceivable that both pull back at the same time (for those or other reasons). A stronger dollar is a negative factor for dollar-denominated commodity prices, all else being equal. The “all else being equal” is a crucial part of that statement. Hope that helps!

Taofeek

Fair enough! Thanks for the explanation!

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[…] More important is the fact that crude oil prices are always quoted in US dollars. This means that no matter where you are in the world, you are essentially paying for oil in dollars. As a result, the price of oil is inversely related to the price of the US greenback. […]

[…] More important is the fact that crude oil prices are always quoted in US dollars. This means that no matter where you are in the world, you are essentially paying for oil in dollars. As a result, the price of oil is inversely related to the price of the US greenback. […]

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