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Inverse Relationship between Dollar Index Basket And Commodity

For decades, a fascinating dance has played out in the global financial arena, one where two powerful forces move in opposing directions. On one side stands the dollar index basket, a measure of the US dollar’s strength against a group of major currencies. On the other, we have the dynamic world of commodities, raw materials essential for everything from building skyscrapers to fueling our cars. Their movements, though seemingly independent, are intricately entwined, creating a complex yet compelling relationship. there is often an inverse relationship between the dollar index basket and commodity prices. Here’s how it works:

Dollar Index Basket

This is a weighted average of the exchange rates of six major currencies: Euro (EUR), Japanese Yen (JPY), British Pound (GBP), Canadian Dollar (CAD), Swedish Krona (SEK), and Swiss Franc (CHF) expand more It measures the strength of the US dollar relative to these other currencies.expand_more

Commodity Prices

These are the prices of raw materials like oil, metals, and agricultural products. They are traded in dollars internationally expand more

The Logic:

  • When the dollar index basket strengthens (meaning the dollar becomes more valuable compared to other currencies), commodity prices tend to fall.expand_more This is because commodities become more expensive for non-US buyers who need to exchange their currency for dollars to buy them.expand_more
  • Conversely, when the dollar index basket weakens (meaning the dollar becomes less valuable), commodity prices tend to rise.expand more This is because commodities become cheaper for non-US buyers, increasing demand and prices.expand_more


Historical Evidence of the Inverse Relationship between Commodity and the Dollar Index:

While the inverse relationship isn’t absolute, numerous historical periods showcase its influence:

Strong Inverse Relationship:

  • Early 2000s: Following the dot-com bubble burst, the dollar strengthened, and commodity prices fell significantly. Oil, for example, went from $34 per barrel in 2000 to $19 in 2002.
  • 2008 Financial Crisis: As the dollar strengthened during the crisis, major commodities like copper, zinc, and nickel experienced dramatic price declines.
  • Quantitative Easing (QE) Periods: The Federal Reserve’s QE programs (increased dollar supply) often coincide with rising commodity prices due to the weakening dollar. For example, during the QE programs after the 2008 crisis, oil prices reached record highs.

Weaker Inverse Relationship:

  • Mid-2010s: Despite a strengthening dollar, oil prices rose due to supply disruptions in major producer countries, demonstrating the influence of specific events.
  • 2020s: While initially following the inverse trend, the recent rise in both commodity prices and the dollar index highlights the complex interplay of various factors like inflation and geopolitical situations.

However, it’s important to remember:

  • This is a general trend, not an absolute rule. Other factors like supply and demand, economic growth, and geopolitical events can also affect commodity prices.expand_more
  • The inverse relationship may be stronger for some commodities than others.expand_more For example, oil prices are often more sensitive to dollar movements than agricultural prices.
  • The relationship can be short-term or long-term. In the short term, even a small change in the dollar index can impact commodity prices. In the long term, other factors become more important.

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