NCPA - National Center for Policy Analysis


August 11, 2008

Exchange rates can be used to help predict commodity prices.  This idea might seem surprising, but given that commodity prices are extremely volatile and difficult to predict, this new approach to predicting commodity prices has important potential practical value, says the National Bureau of Economic Research.

In their new study, the NBER analyzed quarterly data, gathered over three decades, of the "commodity currencies" of Australia, Canada, New Zealand, South Africa and Chile.  For each country, the researchers aggregated the relevant dollar spot prices in world commodity markets to construct country-specific, export-earnings-weighted commodity price indexes.

The NBER found:

  • These countries produce a variety of primary commodity products that together represent from one quarter to well over one half of each of these countries' export earnings.
  • Each of the five countries has a long history of market-based floating exchange rates.
  • Because they are relatively small players in the overall global commodity market, these countries are "price takers" for the vast majority of their commodity exports.
  • As such, global commodity-price fluctuations serve as easily observable terms-of-trade shocks to these countries' exchange rates and affect a significant share of their exports.

The researchers add that their results are sufficiently robust to be applied to alternative benchmark currencies, forecast combinations and long-horizon predictions.

"One might eventually extend the approach," they suggest, "to look at countries that have few or no commodities, such as most of Asia, to see if commodity prices affect the value of their currencies, and if their currency fluctuations may offer predictive power for, say, oil prices."

Source: Yu-Chin Chen, Kenneth Rogoff and Barbara Rossi, "Can Exchange Rates Forecast Commodity Prices?" NBER Working Paper, No. 13901, March 2008.

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