GDP, Forex, and Commodities Relationships - Vintage Value Investing

When people talk about applying determinism in financial market trading, they’re referring to the ability to uncover the underlying laws and clauses that trigger seemingly random market events.

This is an often overlooked skill, and one that makes the difference between successful and failed trades in volatile marketplaces.

By it’s nature, determinism also covers the complex relationships that exist between various alternative markets and asset classes, while offering an insight into how they may be affected by various macroeconomic developments.

If we consider GDP and currency, for example, we see two intrinsically linked concepts that tend to move as one in response to market events. In this article, we’ll explore this a little closer, while also explaining how a nation’s GDP and domestic currency fare when they rely heavily on specific commodities.

The Relationship between GDP and Currency Explained

To some, headline GDP (gross domestic product) is little more than a representation of a country’s economic health and productivity. There is more than a little truth to this, of course, with a high GDP growth rate typically indicative of overall economic growth in the country and a negative GDP growth rate considered to be a key indicator used by economists to define recession.

When countries achieve a high GDP, they also see an increase in the value of their domestic currency, as each individual unit can be theoretically traded for more valuable goods and services. As a result of this, customers may benefit from deflation and more affordable goods, while those who trade forex can subsequently capitalize through investment.

Conversely, countries gripped by a low GDP tend to see the value of their currency depreciate, while inflation increases at a disproportionate rate. This is bad news for consumers, of course, although the derivative nature of forex trading means that investors can still profit by hedging against the afflicted currency.

What Happens when GDP and Currency is Linked to a Commodity?

As with any financial market rule, it is not fixed and could possibly be altered by any number of variables. It’s also interesting to note what happens when a country’s GDP and currency are intrinsically linked to a specific commodity, as this can also have a considerable impact on economic performance and growth. This is particularly relevant when nation’s are overly reliant on a specific commodity, as this can cause huge instability and a debilitating cycle of boom and bust.

As we’ve seen with the Middle East economy, for example, nations such as Saudi Arabia saw their GDP incur a significant hit when oil prices began to plummet towards the end of 2016. As the production of supply continued to rise at a disproportionate rate to supply, oil prices slumped to record lows of $30 per barrel and the entire economy was undermined.

More specifically, the value of the Saudi riyal depreciated while the nation’s budget deficit soared to record highs. Similarly, credit agency Fitch cut the country’s rating from AA- to A+, which in turn impacted Saudi Arabia’s ability to secure credit and drive economic growth in the near-term.

This situation was eased by the OPEC’s drive to cap oil production across the globe, of course, but it’s also interesting to note that the Saudi government reacted decisively to the development. Like a number of other Middle Eastern countries with an over-reliance on oil, Saudi Arabia began a process of diversification that embraced a wider range of products and services to underpin more sustainable GDP growth in the longer-term.

The Bottom Line

While the relationship between GDP and currency is relatively simple and reliable, nations are more likely to see these values fluctuate wildly in instances where they are overly reliant on a single commodity or asset class. So, in the quest for a more consistent GDP growth and consistent currency performance, economic diversification has become a key concept in the current climate.