Commodity currencies involve currencies from countries that have large quantities of raw materials. The three most popular commodity currencies for trading are the Australian, Canadian and New Zealand dollar.
Some of these currencies delivered a strong performance in the closing weeks of the previous year. For instance, the Australian dollar (the aussie) gained more than 3% in December against the U.S. dollar, while the New Zealand dollar (the kiwi) appreciated nearly 5% against the greenback.
Usually, these trends should have resumed into the new year but that’s not quite the case. The major reason behind this is the fact that commodity currency pairings are closely attached to risk aversion, an environment in which traders unload their positions in higher-yielding assets, such as stocks, and shift their funds towards safe-haven assets e.g. gold, the Japanese yen, Swiss franc etc.
As a result, a mix of these currencies with the Japanese yen create the ultimate risk on/off barometar i.e. these pairs tend to decline when risk aversion overwhelms the markets, and vice versa.
When the risk appetite deteriorates, traders activate the so-called “risk-off” approach which almost always leads to sell-off of the commodity currencies. Thus, market analysts consider following instruments as reliable barometers of the broad market sentiment. Based on the performance of commodity currencies, we “calculate” the level of risk that investors are taking in the market.
Having said this, investing in commodity currencies this month is not advised due to a deterioration in risk appetite in the Mideast. However, if the risk appetite suddenly improves, we can expect a relief rally.
For example, NZD/JPY recorded the worst day in around 10 weeks on the day when the U.S. assassinated the top Iranian general as it depreciated almost 1%. The pair then continued moving lower on the worsening risk sentiment in the Middle East. Similarly, AUD/JPY depreciated 1.13% in a single day as it followed the stock market lower.
Due to its close association with the broad risk sentiment, commodity currencies are not expected to perform very well this month. The new year has started with the renewed tensions in the Mideast, which are likely to keep the cap on the commodity currencies against safe-haven assets such as JPY, CHF and USD.