Modelling the rand and commodity prices: A Granger causality and cointegration analysis

This paper examines the ‘commodity currency’ hypothesis of the Rand, that is, the postulate that the currency moves in line with commodity prices, and analyses the associated causality using nominal data between 1996 and 2010. We address both the short run and long run relationship between commodity prices and exchange rates. We find that while the levels of the series of both assets are difference stationary, they are not cointegrated. Further, we find the two variables are negatively related, with strong and significant causality running from commodity prices to the exchange rate and not vice versa, implying exogeneity in the determination of commodity prices with respect to the nominal exchange rate. The strength of the relationship is significantly weaker than other OECD commodity currencies. We surmise that the relationship is dynamic over time owing to the portfolio-rebalance argument and the Commodity Terms of Trade (CTT) effect and, in the absence of an error correction mechanism, this disconnect may be prolonged. For commodity and currency market participants, this implies that while futures and forward commodity prices may be useful leading indicators of future currency movements, the price risk management strategies may need to be recalibrated over time.