2.1 Commodity markets
Almost all commodities are quoted in USD. For an investor, this is the first important distinguishing characteristic. When the current prices of oil, gold or other goods are discussed in the media, they are almost always referred to in USD. This is because the vast majority of commodities are traded on American markets or at least settled in USD.
Thus the USD is always considered as the official currency even for the majority of commodities quoted in London, for example.
However, some commodity certificates are traded in currencies other than USD. Consequently, when determining the price of commodity certificates, the relevant exchange rate set by the foreign exchange market must also always be taken into account. This is because the USD commodity price must be converted into another currency.
This has two consequences for the investor: First, the fair value of the certificate cannot be derived directly from the commodity listing. Second, an additional factor comes into play due to exchange rate volatility, which can have a positive as well as negative impact on performance.
To illustrate this with an example, let us assume that an underlying commodity is trading at a price of USD 100, and the EUR/USD exchange rate is 1.25. If the certificate reflects the value of the commodity on a ‘one-to-one’ basis, then the certificate will be worth EUR 80 (100 divided by 1.25). If the EUR/USD exchange rate remains unchanged, then the investor could focus solely on the price movements in the commodity.
In reality, however, foreign exchange markets are highly unlikely to stand still. Therefore, investors should be aware of possible effects of exchange rate movements prior to the purchase of a commodity certificate.
As the table shows, a decrease in the euro has a positive impact on the price of the certificate.
For example, assuming that the price of the underlying asset remains unchanged, a drop in the EUR from USD 1.25 to 1.10 would lead to investors recording an increase in the price of the certificate of almost 14 percent as a result of the currency effect alone.
However, if the euro were to increase against the US currency to EUR/USD 1.40, investors would suffer a loss in the value of the example certificate of nearly 11 percent, assuming that the price of the underlying asset has not changed.
Impact of currency movements on certificates
Current price of the underlying asset USD 100.00
Current euro exchange rate: USD 1.25
Current price of the certificate: EUR 80.00
Price movements as a result of changes in EUR/USD
EUR exchange rate Certificate price in EUR Certificate price change