Influence of commodity prices on exchange rate

26 May, 2023 - 00:05 0 Views
Influence of commodity prices on exchange rate

eBusiness Weekly

With the USD/ZAR trading at all-time high levels of above R19.5 and exhibiting extreme signs of weakness against the USD and other major currencies, you cannot help but ask where it is heading.

Traditionally, there are several factors impacting a currency. To name a few impacting the ZAR specifically:

Inflation and interest rate differentials;

Public debt and economic growth levels;

Political risk that could increase the country’s risk premium;

USD strength or lack thereof; and

Commodity prices and their influence on our trading figures.

The largest contributors at present are probably the first three and they receive ample media attention, so for the purpose of this article, I will focus on the last two points.

As seen in the graph below, the USD index has enjoyed a strong run recently, rising from levels close to 90 in 2021 to above 110 in late 2022.

What is clear, is the significant under-performance the ZAR experienced since the beginning of 2023. This is in contrast with strong relative periods experienced in 2021 and 2022.

When looking at the graph below, one can clearly see an inverse correlation between the USD/ZAR and the LME (London Metals Exchange) index. The LME index is used only for indicative purposes, but one needs to consider which commodities are relevant to our country’s specific commodity export basket. This recent weakness in commodity prices helps to explain some of the relative weakness of the ZAR.

According to Stats SA data to the end of January 2023, the largest contributors to mineral sales were PGMs (Platinum Group Metals) and coal, both of which have experienced significant price declines in the last few months. This in turn will put pressure on our current account as well as our trade balance, which does not bode well for our currency.

Although not the only factor to consider, the commodity price declines shown below certainly play a significant role in the demand for our currency and have added to the weakness we witnessed recently.

When looking at the above factors, there are several aspects to consider when moving money offshore, and the impact of commodity prices will be only one of these. Apart from your personal financial needs and objectives, it is always important to refrain from emotional decision-making driven by news headlines.

Commodity prices tend to move in cycles as supply and demand dynamics find a price equilibrium over time. It may seem that we have reached a short-term peak in the LME Index as shown in the graphs above. This peak can mainly be attributed to expectations for commodity shortages spurred by the onset of the Russian invasion of Ukraine.

One thing is for certain, commodity prices play a significant role in the demand for our currency and the positive commodity price cycle experience over the last three years is certainly an important factor to keep in mind. — Moneyweb


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