Understanding important facts as the key of intermarket relationships

Financial markets are a system of connected vessels. If the value of the bonds falls or increases significantly, this can influence the price of currencies and equities. This is not a general rule, but there are some instruments that historically evolve in a very similar way. Why ? There are several reasons. The Canadian dollar is a perfect example. The currency is highly correlated with oil because it has a significant impact on the Canadian economy. Let’s see some major correlations to see how they can be used in your trading strategies.

How do you measure the correlation?

Correlation is one of the most common statistics. A correlation is a unique number that describes the degree of the relationship established between two assets. It can be used for individual stocks or assets, or it can measures how a market evolves relative to another market. The scale of measurement is from -1 to +1. A perfect positive correlation between two assets will be in the form of +1. A perfect negative correlation will be in the form of -1. Yet, this is extremely rare.

As you can see, there is a pretty good correlation between the Canadian dollar and oil. The correlation works in a positive way as the market moves in a similar way. The oil increases the dollar increases and so on.

AUD vs. Iron-ore

The Australian dollar is a commodity-sensitive currency, which means its strength depends mainly on the prices of specific commodities. Australia is the world’s largest iron ore producer and it is not surprising that the economy’s wealth and the value of its currency are highly dependent on the evolution of iron ore. As a result, the outlook for this commodity may well be viewed as an evolution indicator for the Australian dollar.

NZD vs. Prices of Dairy Products

Like Canada, New Zealand is highly dependent on milk prices. Unlike oil or gold, milk is not a commodity that is actually taken into account by traders. In addition, you will very rarely hear information about the price of milk on TV or radio. This does not mean that milk is not vital when trading NZD.

One could say that New Zealand is Saudi Arabia’s milk. It is the largest exporter of dairy products in the world accounting for 40% of international transactions. Dairy products represent 7% of the country’s total economic performance. In addition, the largest dairy exporting company in the world, Fonterra, is also the largest company in New Zealand. As you have understood, a deterioration in milk prices could affect the entire New Zealand economy, leading to a weaker currency. When milk prices are high, importing countries usually have to buy several New Zealand dollars to buy their milk. When the price of milk decreases, the demand for the New Zealand dollar falls and its value may decrease as well.

USD and gold

Yet, there is a strong reverse correlation between the dollar and gold but it is an inverse correlation. An inverse correlation is known as a negative correlation, an opposite relationship established between two markets. So when the value of a market goes up, usually the other one goes down. This is due to two important reasons:

• The falling dollar may increase the value of other currencies. This often leads to increased demand for commodities, including gold.

• When the value of the dollar starts to fall, traders look for alternative sources to store value, because a dollar decline and normally correlate to lower interest rates. As rates are lower, traders look for returns elsewhere and gold can be an alternative.