Oil Currencies

Oil and The Canadian Dollar (CAD)

Oil is one of the most traded commodities in the world. Consequently, Its change has a ripple effect on many economies and countries. When discussing oil, most people refer to the Middle East and their vast oil reserves. In fact, it is often forgotten that Canada is one of the world’s biggest exporter of oil and holds the largest oil reserves in the world. Canada’s booming economy has been fueled by the climb in oil which has in turn transferred into the domestic economy. Thus, the Canadian currency has a direct correlation with the price of oil.

Likewise, the US currency is said to be inversely correlated with oil prices. With the U.S being one of the biggest oil consumers in the world, a rise in oil prices would weigh heavily on consumer spending. The lower the price of oil, the more beneficial it is for the US economy as discretionary income of US consumers increases. Therefore if oil does crash, this fear of an economic slowdown will be greatly alleviated and be taken as a promising sign by dollar bulls. Traders must also be wondering why the U.S does not benefit from the rise in oil prices, this is because most central banks reserves consist mainly of dollars, in other words they do not need to convert additional dollars to fund new purchases.

In terms of trading, the USD/CAD pair is perfect to trade against rising or falling oil prices. When oil prices rise, the USD/CAD falls. Similarly, when oil prices falls, the USD/CAD falls. As shown below, the graph shows a positive correlation between CAD/USD (Reversed) vs. avg. oil price. The long term economic impact of oil prices on each of the economies is more significant than the short term currency impact. For instance, if oil prices continue to slip, the Bank of Canada would be forced to cut short term interest rates which would greatly lower the CAD. Another benefit from holding the USD/CAD pair is the carry trade benefit. If a trader were to hold 1 lot of the pair, he or she would earn an interest of $2.80 per day. Therefore, the USD/CAD pair rather than oil futures is a more favorable option for trading when using oil as a basis. 

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