The Dollar & Commodities Dance

There's an interesting article on WSJ.Com today https://www.wsj.com/articles/strong-dollar-fuels-pullback-in-commodity-markets-11658223085 that speaks to another impact of a strong dollar: it has been weakening commodity prices. We won't get into the reasons here but instead wanted to show how a tool like Excalibur Pro not only can help you detect developments like this - but explain how you can follow them over time.

This first screenshot below is a Watchlist that we created that shows the 5-day average correlation values for a host of commodities against the U.S. Dollar Index as of July 18 (yesterday). Click on a value in the Watchlist (when you are on our website) and the chart to the right shows you a 6-month chart of that relationship. Here, we've clicked on the dollar index and gold and you can see, that this negative relationship has been pretty prevalent most of this year.

So, a trader making a broad bet on the dollar going higher or lower can correspondingly bet against a commodity that the index is highly correlated with. But a potential problem with trading the index is that country-specific issues can skew that trade.

Another approach is to look at specific currencies from countries whose economies are linked strongly with commodities that they produce. We have created another Watchlist on Excalibur Pro that tracks 10 such relationships (we called our Commodities FX; you can create your own Watchlists with other relationships). Here is our Watchlist:

We have identified some common Commodity FX relationships. Check out Gold & the Australian Dollar (AUDUSD). Note that this positive correlation relationship is usually strong and that when it dips into negative territory, there could be an opportunity. What we are showing here is one of several examples on this Watchlist that present similar opportunities - the others being MXNUSD-Silver and BRLUSD-Coffee Arabica.

Now, taking this one step further, we also have a tool on Excalibur Pro that helps you back-test statistical arbitrage strategies. One that has worked well recently (and note that like any trading strategy, they don't guarantee results) is the Correlation Pair Trading strategy (below):

Here we are monitoring the relationship between Gold and AUDUSD, starting June 1. We first tested for stationarity (using the Augmented Dickey Fuller test) to make sure that in the past year this pair statistically met the necessary mean and variance parameters (note we said in the past year and are not predicting that to remain the case going forward). We look at how the current ratio of the two instruments deviates from the average and decide to enter/exit a potential trade on whatever standard deviations of the average we want to test.

In this example, we enter at 1 standard deviation and exit at the average (you can exit whenever you want, of course to maximize a gain or minimize a loss). This pair qualified for a trade on June 10 (a Friday) which was to short gold and go long AUDUSD. On June 13 (the following Monday), that trade showed a return of 0.619%, which was an annualized return of almost 364%.

Again, it is important to note that these trading strategies do not guarantee results. Timing is important (when to exit a trade) and the prospect that the conditions that existed that make a particular statistical arbitrage opportunity favorable could have changed. We ran this same pair through our Cointegration and Distance trading strategies for the same time period and there were some gains and there were some losses.

One other note: trading commodity futures contracts can be tricky for a number of reasons. But there are ways other than futures - things like ETFs that represent different baskets of commodities and different dollar indexes.

Excalibur Pro isn't intended to guarantee any results. Instead, we provide the tools to help you discover data relationships that you may decide to use in a trading or investing situation.