I’m asking because I’ve heard that buying commodities is a good hedge in the event that the value of the dollar declines a significant amount. But I want to make sure that I understand things more clearly. Let’s say that it costs $50 for a barrel of oil on a commodities exchange. Now let’s say that in an unlikely, hypothetical situation, the exchange rate of a dollar doubles against all other currencies, overnight (ie – before 1.5 dollars = 1 euro; now 3 dollars = 1 euro, etc.). Given that the overall global demand/value of oil has not changed, would the value of a barrel of oil on the commodities exchange now cost $100? (given that the value of a dollar is half of what it used to be?)
Thanks!
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2 Responses
Yes, it would now be worth more in terms of dollars. For one barrel of oil, you would get more dollars. Of course, if the dollar devalues, it won’t do you much good if you’re domestic–dollars now buy less in general.
So, buying commodities works as a hedge against fluctuations in exchange rates. They will retain value in foreign currencies when the dollar depreciates. If you were holding $50,000, and the dollar’s value dropped in half, you now have only $25,000 in purchasing power. If you had been holding a commodity, its price would increase to reflect the change in exchange rates. Or, you could even cash out into a foreign currency.
You are on the right track.
Posted on May 16th, 2010 at 3:48 am
Your situation is exactly correct. The two biggest reasons that the dollar (or any currency) should change price is either a change in the amount of the money, or a change in the demand in the currency.
Assuming that the US is not engaged in a serious war (and that was had no effect on the rest of the world), nor if the US economy takes a sharp turn towards socialism, then you should not expect the demand for the US dollar to change much. The only thing that would cuase such a change would be a sharp rise in the amount of dollars in the economy. This, generally, can be caused by extremely low interest rates, or the government decides to print up a whole lot more money.
When a stock does a 2:1 split, everybody who owns stock in that company, will now own twice as many shares, but the price will be cut in half. Each share now has half of the buying power. Now if the money supply doubles, you can expect each dollar to buy half as much. That means everything (including commodoties and foreign currencies) will double in price
Commodoties are a good hedge against inflation. I prefer using gold as the commodity (it is less consumable than most others, and the supply tends to stay stable). Owning stock, bonds, and bank accounts in foreign countries is also another great hedge against inflation and a falling dollar.
Everybody dreams of playing the stock market well enough to retire, but I wish more people realized, as you have, that inflation is always a risk that can be devistating. Commodities are not as sexy, but very vital.
Posted on May 16th, 2010 at 4:25 am
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