CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

27.2 COMMODITIES AND EXCHANGE RATES

Commodities account for a quarter of merchandise trade, which again accounts for a quarter of the world gross domestic product (GDP). Since many developing countries depend on the export of only a few commodities, it is important to understand the effects of exchange rate deviations on commodity prices. Many commodities are denominated in U.S. dollars, so exchange rate movements vis-à-vis the dollar affect the prices for exporters and importers of commodities. Thus, in addition to the market risk, investors also face exchange rate risk.

However, the effects of a volatile exchange rate go beyond the investors' risk. A general depreciation of the dollar increases dollar-denominated commodity prices, as commodity exporters from other countries demand a higher price in return for the exchange rate loss, and vice versa.12 Exchange rate movements of single currencies can have substantial effects on the profits of commodity-producing firms as well as on supply changes.13 One prominent example is the case of South Africa, where the rand depreciated against the dollar by 35% in 2001, while at the same time the gold price in dollars actually decreased by 2.9%. This raised profits of South African gold companies, which expanded production in the following period. However, it should be noticed that the supply of nonstorable commodities is fixed in the short run, since investment in commodity infrastructure can take years, so price movements can be caused ...