Decline of the US Dollar Means Commodities Will Continue To RoarThe pound sterling, the United Kingdom’s foreign currency instrument, was the global reserve currency in the 19th century and the first half of the 20th century. For decades, the US dollar has been the world’s reserve currency, which became official in 1944 after a delegation from forty-four allied countries decided that the world’s currencies would no longer be linked to gold but pegged to the US dollar, which was linked to gold. The Bretton Woods Agreement established the authority of central banks to maintain fixed exchange rates between their foreign exchange instruments and the US dollar. In turn, the US would redeem US dollars for gold on demand. The redemption option ended in 1971 when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value.
The dollar’s link to commodities
Three factors that will continue to weigh on the dollar’s global role
Expect higher base prices for commodities
Long-term trends are very bullish
Buying dips is likely to be the optimal approach
For seventy-eight years, since the end of World War II, the US dollar has been the king of the currencies. On December 27, 1945, the participating countries signed the Bretton Woods Agreement. On August 15, 1971, President Nixon abandoned the gold standard. On February 4, 2022, a handshake on a “no-limits” support agreement between Chinese President Xi and Russian President Putin may go down in history as the beginning of the end of the US dollar as the leading world reserve currency. The watershed event could have far-reaching consequences for markets across all asset classes. Commodities are global assets. The end of the dollar’s reign as the monarch of money will likely lift raw material prices in dollar terms in the coming years.
The dollar’s link to commodities
As the world’s reserve currency, the dollar has been the leading global pricing mechanism for most commodities. Over the past decades, a rising dollar often weighed on commodity prices as the essentials became more expensive in other currency terms. A weak dollar encouraged buying as prices fell in different foreign exchange instruments.
While the US is the world’s leading economy, the population at around 333 million is only 4.2% of the total number of people on our planet. Therefore, the dollar’s link to commodities is financially based on the US position in the global financial markets and not on the supply and demand equations for the raw materials.
If the dollar’s role in the world declines, its link to commodity prices will diminish.
Three factors that will continue to weigh on the dollar’s global role
King dollar is facing a challenge in 2022 as world economic and political events threaten its dominance. The US dollar faces at least three issues that continue to erode its purchasing power and role in the global economy:
Inflation - The February US CPI and PPI data pointed to the highest inflation in over four decades. The March data will be even worse. The Fed began increasing short-term interest rates but remains far behind the inflationary curve. Rising inflation erodes the US dollar’s purchasing power.
Geopolitical tensions - The war in Ukraine and China’s support for Russia has dramatically changed the geopolitical landscape. In the leadup to the expansionary move, Russia reduced its US dollar reserves, increasing holdings in euros and gold. Sanctions on Russia will likely cause China to follow the same course. China is the world’s second-leading economy, and Russia is a leading commodity-producing country. As China and Russia move away from using the US currency as a reserve currency, the dollar’s global role will decline. Geopolitical tensions have accelerated the descent.
The decline of fiat currencies - The rise of cryptocurrencies is a sign of the fall of fiat currencies. Cryptos derive value from bids and offers for the currencies in an open and transparent market that transcends borders. Fiat currencies derive value from the full faith and credit in the governments that issue the legal tender. Meanwhile, rising commodity prices signify the decline in the dollar’s purchasing power.
The dollar index measures the US currency against other world currencies, but it is a bit of a mirage as when all fiat currencies lose value, it is not apparent. The dollar index measures the US currency against other world reserve currencies, including the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc. The most significant weighting, at 57.6%, is against the euro currency. The dollar may be moving higher against the basket of currencies, but that does not mean that all of them, including the dollar, are losing value.
Expect higher base prices for commodities
The decline of the dollar and all fiat currencies makes purchasing power drop and commodity prices rise. Therefore, a strong dollar index has not weighed on many commodity prices over the past year.
The weekly chart shows that the dollar index has rallied, making higher lows and higher highs since early 2021. Over that period, most commodities have risen to multi-year and all-time highs. The strength of the dollar did nothing to restrain increasing raw material prices.
Meanwhile, higher US interest rates increase the cost of carrying commodity inventories and boost the US dollar’s value against other currencies.
The weekly chart of the US 30-Year Treasury bond futures shows the pattern of lower highs and lower lows, pushing long-term interest rates higher.
The bottom line is that a rising dollar and increasing US interest rates have not stopped commodity prices from rallying since early 2021.
Higher interest rates, rising inflation, geopolitical turmoil leading to supply chain issues, and sanctions that interfere with many raw materials supply and demand equations mean that production costs are rising. The base prices for raw materials are moving higher.
Long-term trends are very bullish
Bull markets rarely move in straight lines, and since commodities are highly volatile assets, corrections can be brutal. However, the long-term charts in four leading commodities, copper, crude oil, corn, and gold, display the same bullish patterns.
The quarterly chart of COMEX copper futures shows the bullish pattern over the past two decades.
The highly political crude oil market displays the path of least resistance of the price is higher. US energy policy and geopolitical turmoil have only exacerbated the upward trajectory of the energy commodity since April 2020.
Corn’s price path has been higher, making higher highs and higher lows for decades.
Gold’s bull market dates back over two decades. Gold may be the best example of the decline in fiat currency values as it is a hybrid between a commodity and a foreign exchange instrument.
Many other commodities display the same long-term trends. The recent strength in the US dollar means that commodity prices in other currencies have followed even more bullish price paths over the past year.
Buying dips is likely to be the optimal approach
The trend is always your best friend in markets. While short-term and medium-term traders follow technicals that depend on the market’s sentiment, long-term trends are a function of macro and microeconomic factors. The decline of fiat currency values continues to push commodity prices higher.
Over the past decades, price corrections have been long-term buying opportunities in the commodities asset class. The economic and geopolitical landscapes point to a continuation of the trend. Buying on price weakness has offered optimal results. Even if the US dollar index continues to rise, it will not mean the currency is strong. The foreign exchange market is a mirage that only measures one fiat currency’s value against another. Commodity prices are the actual value indicator, and the long-term trends reveal that currencies are all losing purchasing power.
We remain bullish on commodities. However, the higher the prices, the more vicious the corrections will become. Buying when they look the worse could be the best course of action over the coming months and years.
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