Educational

Intermarket Correlations Part 1: How Different Assets Affect Each Other

Intermarket correlations may sound highfaluting, but it doesn’t really take a rocket scientist to understand what it means.

Intermarket correlation is basically the correlations of different assets across different markets.  It talks about how much independence one asset sports from another one.

Intermarket correlations - analytical images come out of a book on a table

 

You’d be surprise with how interrelated the assets are.  Let’s dig into it.

Intermarket Correlations: Gold and the AUD/USD and USD/CHF

Before we jump into the details, you have to know that the gold commodity doesn’t really go along well with the USD.  Usually, when the dollar’s having a good day, the gold’s down in the doldrums.  And when the gold is having a good time, the dollar quite feels down.

The logic behind this is that when there’s economic unrest, investors ditch the dollar for the gold.  And different from other assets, the precious metal gold maintains its shine or its intrinsic value.

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Gold and AUD/USD

These days, the inverse relationship between the gold and the dollar still holds true.  But the dynamics have somehow changed.

The dollar has this kind of reassuring appeal for investors.  And because of that, investors tend to fall back on the dollar in time’s economic trouble.  The opposite takes place when there’s sign of growth.

Currently, Australia stands as the third biggest gold producer in the world.  It sails out a staggering $5 billion worth of the yellow treasure every year.

Now, this might surprise you, but the gold has a positive correction with AUD/USD.  That means that when gold perks up, the AUD/USD rise up to the occasion.  When the gold feels down, the AUD/USD also wakes up on the wrong side of the bed.

Gold bars on top of dollar bills

History would show you that AUD/USD has had an 80 percent correlation with the gold.

SEE ALSO: Best Currency Pairs to Trade

 

Gold and USD/CHF

Around the world, the Swiss franc is another currency with a strong connection with the gold.   The currency pair USD/CHF has the dollar as its base currency.   And this pair usually strengthens as the gold weakens.

If you’re curious why the Swiss franc has this strong link with the gold, we’ll tell you.  Not like the Australian dollar, CHF moves along with gold because gold reserves back more than 25 percent of Switzerland’s money.

That means gold has a negative correlation with the USD/CHF currency pair.

READ FURTHER: Currency Pairs: the Best Choices

 

Intermarket Correlations: Oil and USD/CAD

Like gold, oil is a very in demand commodity.  And oil is just as important as gold, if not more important than the precious metal.  In fact, many market participants refer to oil as the black gold.

Oil has a very important role in the global economy.  It’s something that the market cannot go on without.

oil barrels on top of dollar bills

Canada is one of the top oil producers in the world.  It exports more than 3 million barrels of oil and petroleum products on a daily basis to the United States.  This figure places it as the largest supplier of oil to the US.

Due to this huge volume, there exists a tremendous amount of demand for the Canadian dollar.  Bear in mind, too, that Canada’s economy is reliant on exports.  Around 85 percent of its exports go to the US.

And because of that dependence, consumer’s reaction to oil prices movements can great affect the USD/CAD currency pair.

If US demand increases, manufactures will order more oil to keep with the demand.  This can then result to an increase in oil prices.  That means a slump in USD/CAD.

If, on the other hand, US demand decreases, manufacturers will usually lie down a bit they don’t need to dish out more goods.  The demand for oil will fall, which could then hurt demand for the Canadian dollar.

Oil has a negative correlation with US/CAD.  That’s around 93 percent between the years 2000 and 2016.

When oil goes up, the USD/CAD slumps.  And when the oil goes down, USD/CAD soars.

The Changing Relationship between Oil and the US Dollar

According to history, the US dollar has an inverse relationship with oil prices.  This comes from two main premises.

  • A barrel of oil is denominated in US dollars around the world. So when the dollar is strong, you have to have fewer US dollars to purchase a barrel.  On the flip side, if the dollar is weak, oil prices rise up.
  • The US has historically been a major IMPORTER of oil. If the oil prices increase, the US’ trade deficit increases.  This is because more dollars go abroad.

The first premise still remains true today.  But the second one has already changed a bit.

The US shale revolution has drastically spurred domestic petroleum production.  That’s thanks to the success of horizontal drilling and fracking technology.

As a matter of fact, the US became a net exporter of refined petroleum products in 2011.  It is now the second largest crude oil producer, just after Russia.

According to the Energy Information and Administration, the US is currently more than 90 percent self-sufficient with total energy consumption.

As oil exports increased, oil imports decreased.  Essentially, higher oil prices no longer affects higher US trade deficit.  It actually now helps to decrease the deficit.

Looking at the new dynamics of the global energy market, it wouldn’t be surprising if the historically negative correlation turns into a positive one.

Because of the US’ growth in the global oil industry, the oil and the United States’ relationships are changing.

Intermarket Correlations: Bond Yields and Currency Movements

A bond is a debt that an entity issues when it needs someone to lend it some money.

Government, municipalities, or multinational companies are among these entities.  These need a lot of funds in order to operate.  This means they often need to borrow from banks or individuals like you.

Bonds written on a board with a pile of coins in front

When you own a government bond, the government has basically borrowed money from you.  You might be asking if that’s just like owning stocks.  But it’s quite different.

RELATED: The Difference between Stocks and Bonds

One huge difference is that bonds usually have a specific term of maturity.  The owner receives the money owned back, and that’s called the principal.  The payment comes on a predetermined set date.  In addition, when you get a bond from a company, you get paid at a specified rate of return.  This is called the bond yield.

The bond yield refers to the rate of return or the interest paid to you as a bondholder.  Meanwhile, the bond price is the amount of money that you paid to get the bond.  Bond yields and bond prices are inversely correlated.  That means when bond prices rise, bond yields slide, and vice versa.

Its relationship with the currency market

Bear in mind that intermarket relationships rule currency price action.  Bond yields in fact serve as a great indicator of a stock market’s strength.

Therefore, US bond yields measure the performance of the US stock market.  This then reflects the demand for the US dollar.

Demand for bonds typically rises when investors become worried about their stock investments.  So they shift to bonds.  This drives bond prices higher, pushing bond yields down.

As more and more investors shift away from stocks and other high risk investments, high demand for US bonds and US dollar pushes their prices higher.

Government bond yields serve as an indicator of the overall direction of a country’s interest rates and expectations.  For instance, if you’re in the US, you’ll likely pay attention to the 10-year Treasury note.  A soaring yield is dollar bullish, while a slumping yield is dollar bearish.

You must then learn the underlying dynamic behind a bond’s yield is rising or falling.  Interest rate expectations can cause this or market uncertainty.  For the latter, there’s a shift to safer investments, with capital flowing away from risky assets.

Bond spreads stand for the difference between two countries’ bond yields.  These differences can give rise to carry trade.  You should monitor bond spreads and expectations for interest rate changes to get an idea.

When the bond spread widens, the currency of the country with the higher bond yield appreciates.  That is, against the other currency of the country with the lower bond yield.

Conclusion

A move in one asset affects another move in another asset.  And the more you are familiar with Intermarket correlations, the more you can use them to your advantage.  This is just the first part; make sure you also read the second part of this discussion.  Learn more about Intermarket correlations!

 

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