Why tracking Dollar Index is must for any commodity trader
The US Dollar Index is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies. Generally dollar index goes up when US Dollar gains against other currencies. It a indication of US Economic activity or any other activity which can strengthen or weaken US dollar.
By Kamlesh Jogi, Sr Technical Analyst, Fortune Financial Services India Ltd.
What is Dollar Index–
The US Dollar Index is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies. It is a weighted geometric mean of the dollar's value compared only with-
- Euro (EUR), 57.6% weight
- Japanese yen (JPY) 13.6% weight
- Pound sterling (GBP), 11.9% weight
- Canadian dollar (CAD), 9.1% weight
- Swedish krona (SEK), 4.2% weight and
- Swiss franc (CHF) 3.6% weight
Generally dollar index goes up when US Dollar gains against other currencies. It a indication of US Economic activity or any other activity which can strengthen or weaken US dollar.
It was started in March 1973, soon after the dismantling of the Bretton Woods system. At its start, the value of the US Dollar Index was 100.000. It has since traded as high as 148.1244 in February 1985, and as low as 70.698 on March 16, 2008. The makeup of the "basket" has been altered only once, when several European currencies were subsumed by the Euro at the start of 1999.
How it affects commodities Move –
Commodities typically follow and inverse relationship with the value of the dollar. When the dollar strengthens against other major currencies, the prices of commodities typically drop. When the value of the dollar weakens against other major currencies, the prices of commodities generally move higher.
You can see from the chart (in the attachment) how this inverse relationship works. The green line represents the price of the dollar index, which is the value of the dollar against a basket of other major currencies. The blue line is the loco Gold, LME 3m Copper and Nymex Crude Oil continuous Weekly chart.
As the dollar moves higher, commodities generally move lower. The opposite happens as the dollar moves lower. It is not a perfect correlation, but it is fairly close.
There are many reasons why the value of the dollar has an impact on commodity prices. The main one is that commodities are priced in dollars. When the value of the dollar drops, it will take more dollars to buy commodities.
Another reason is that commodities are traded around the world. Foreign buyers will purchase US commodities or Dollar denominated.
When the value of the dollar drops, they will have more buying power and simple economics tells us that demand typically increases as prices drop.
Commodity traders often keep a close eye on the value of the dollar. The price of the index is traded like any other futures contract and you can get quotes throughout the day.
Commodity prices don’t necessarily tick higher for every tick lower in the Dollar Index, but there is a strong inverse relationship over time. Individual commodities can also buck the trend if other overwhelming forces are causing the price to move along with the dollar.
Technical Analysis of Dollar Index –
On weekly chart Dollar Index has broken major support line and same time we have seen all major commodities are trading as their 6 month higher levels. Dollar index is expected to remain negative, major support is seen around 78.40. Currently it’s trading near 80.27.
If market doesn’t sustains here and bounce back above 81.40 then we can a sharp rally from current levels, same time we might witness a sharp correction in Gold, Copper and Crude prices.
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