As the Federal Reserve steadies to hold interest rates at a lower level, experts are predicting that the U.S. dollar will continue to weaken this year, thereby boosting commodity prices.
A weaker dollar renders commodities such as oil (NYSE: USO) and precious metals (NYSE: GLD) less expensive for buyers overseas. This inverse relationship results primary due to the fact that the dollar is the benchmark pricing mechanism for most commodities, given that most countries hold U.S. treasuries as the main form of currency on reserve. The more reserves a country has, the higher their buying power, particularly if the dollar weakens against their own currency: it can sell the dollar for its own currency and use that to buy commodities, as a form of exchange rate arbitrage.
This notion, coupled with an improvement in U.S.-China relations, will definitely lift the market heading into the year. Since moves in commodity prices are often driven by fundamental factors, such as fears of a supply shortage or issues that could affect demand, movement in the U.S. dollar can accentuate the effects of these factors and have a positive multiplier effect.
The trade war was a major problem for the copper commodity in particular, according to Darwei Kung, head of commodities and portfolio manager at DWS Group. This is because China is one of the world's largest copper consumers and accounts for almost half of its demand globally.
Rising commodity prices will serve as a headwind for markets, especially because many of the underperforming sectors of the stock market in 2019 were commodity ones. For example, energy stocks (NYSE: XLE) held the top positions among on the New York Stock Exchange new 52-week lows list for several months of the past year.
"We have this great inventory of opportunities, but like other projects in the industry, they require prices higher than today's price to develop," Freeport-McMoRan Chief Executive Richard Adkerson said in August.
That said, the historical correlation between the dollar and commodity prices is just that: a correlation. In fact, Citi Research reported in two years ago that the correlation between the dollar and commodity prices became less significant after the dollar index was trading at about $97 just a year before. In fact, commodities were performing strongly in the second half of 2016 even as the U.S. dollar appreciated, somewhat violating the inverse relationship.