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Second and, perhaps more importantly, this market has changed beyond all recognition in the last ten years, and just like the bond market, is one few forex traders ever consider.

The commodities market is the fulcrum of the financial markets because it is where real currencies are converted into real products, creating a myriad of pivotal relationships, as the world of money meets the real world of economic supply and demand in commodities.

Commodities therefore provide the bridge between global economies and the US dollar, bonds, equities, and of course currencies. Without this bridge and real global market, we would have little idea of what is actually happening in the world. Few forex traders appreciate the significance of this market, not only in terms of its position at the centre of the money flow, but also in terms of how this market is viewed, by both central banks and governments alike in their key decisions.

Commodities are a key component to your trading success. As traders we have to understand them, the signals they are sending regarding the economy, associated markets, and of course money flow and risk appetite.

Put simply, commodities are the shop window of the world – a trading post, a giant store where real goods are exchanged for money and money is exchanged for real goods. The ultimate warehouse on a grand scale.

The commodities market was founded on the need for farmers in the US mid West to have a fair and equitable market in which to sell their crops and livestock. From this, the futures market was born, which is why many of the largest futures exchanges, such as the CME (Chicago Mercantile Exchange) and the CBOT (Chicago Board of Trade) are still based in Chicago, with these two exchanges merging in 2007.

A futures contract is simply a contract between two parties which specifies that on a certain date in the future, the producer or holder of the contract agrees to deliver a specified quantity of the goods, at a specified time, for an agreed price.

In this way, growers and producers in the mid West were able to agree a price for crops and livestock for delivery in the future. This in turn removed the uncertainty of future price fluctuations caused by natural events, such as poor growing conditions, bad weather, natural disasters and world conflicts, allowing both parties to plan their cash flow accordingly.

Over time, the commodities market expanded to include not just the agricultural sectors, such as corn, wheat, dairy, livestock, coffee and cocoa, but into a huge variety of sectors, including metals, (precious, industrial and base), along with energy sectors, such as oil and gas, index futures such the S&P500, and other financial instruments.

As we moved into the 21st century, everything changed with the advent of electronic trading. No longer was it necessary to call a specialist broker and instruct then to execute a buy or sell order for wheat or cotton. Now it was possible to trade online virtually 24 hours a day.

This simple innovation has changed the commodities market from one of a simple supermarket to one where commodities are now considered as an asset class, just like any other. This is also the case with currencies, which just like commodities, are bought and sold as an asset, and not purely for short term speculative gains.

One of the common misconceptions is that commodity exchanges determine or establish the prices at which commodity futures are bought and sold. This is false. Prices are determined solely by supply and demand.

If there are more buyers than sellers, the price will rise. If there are more sellers than buyers the price will fall. This is generally referred to as 'price discovery', but in simple terms all this means is that this is a free market, where prices find their natural level. This is why the commodities market is so important and why it gives us so many signals as a result.

The second would be the economic relationship with inflation. This is a key reason why we monitor the commodities markets so closely and which also explains why there is such a close relationship with bonds.

However, we now have to add a third strand to the analysis, which is money flow, since commodities are considered to be an asset class in their own right. This means commodity futures and, in some cases, the physical asset is being bought and sold as an investment, either speculatively or for a longer term buy and hold. This is a similar approach to that in equity markets and, as a result, commodities can now tell us a great deal about risk and market sentiment.

Later in this chapter I will be considering some of the individual commodities in detail, such as gold, oil, copper and, of course, the US dollar, but the key point to start with is this – commodities and fundamentals go hand in hand.

When interest rates rise, for example, commodities are likely to perform well. And the reason is because rising rates are likely to indicate increasing global demand, which in turn drives inflation into an economy, which is good for growth.

Commodities give us a classic view of global demand for raw goods and with their key relationship with the US dollar reveal both money flow and market sentiment. Indeed it could be argued that to be successful as a forex trader, you simply need to have a clear view on the US dollar, since every other market, from bonds, commodities, equities and currencies is US dollar centric. The dollar remains the currency of first reserve and until an alternative is found, will remain so for the foreseeable future.

Whilst forex markets underpin the other three, it is commodities which provide the real world linkage, the bridge between money and goods. They are the fuel of the economy. Japan cannot make cars without steel. Nothing moves without oil. The mobile phone market needs rare earth metals, and you cannot feed the world without wheat, corn or soybeans.

The complicating factor now, of course, is that we have to view some commodities as an asset class in their own right and therefore be careful in our conclusions and analysis. Later in this chapter we are going to consider some of the key relationships such as commodities and bonds, and commodities and the US dollar which will help in confirming any conclusions we may make. However, before doing so, I would like to spend a few moments considering the broad sectors, and some of the key commodities in each.

In general there are three principle sectors, namely agriculture, energy and metals. Agriculture covers all the basic staple products such as wheat and corn, and soybean for which China is the largest market. There is also rice, cattle and timber along with kitchen staples such as orange juice, sugar, coffee and cocoa. All of these are basic commodities, and there is always an argument that says with an increasing world population and falling acreage, soft commodities are almost guaranteed to increase in price. After all, soft commodities are governed by supply and demand, and with increasing demand and falling supply due to a decline in arable land in emerging markets, longer term soft commodity prices look set to rise. This was reinforced recently with China's decision to begin importing corn for the first time.

However, rising commodity prices, whether in the soft or hard sector mean one thing longer term, and that's inflation. With inflation comes higher interest rates, which are then reflected in bond markets and interest rate differentials between currency pairs, with consequent money flow as a result.

In the metals sector there are three that we pay particular attention to, namely gold, silver and copper. Gold,of course is the ultimate safe haven hard asset, and whilst silver is also considered in the same vein as a precious metal, it is in fact classified as an industrial metal.

Silver's main benefit is its conductive properties, and is used in a variety of manufacturing processes and components. It's also treated as a precious metal, particularly since gold's rise to almost $2000 per ounce and now trading in the $1300 per ounce region. Finally, in the metals sector we have copper, which is considered a bellwether for the global economy, and has a close relationship to equities, as a result.

The third group is the energy sector which includes oil in all its various forms along with natural gas and electricity. Of these, oil is the key commodity, and again one we look at in detail shortly.

Finally just to round off this introduction to the commodities market, there is one further element which has changed this market dramatically in the last few years, and that's the rise in popularity of the ETF or Exchange Traded Fund.

These are investment funds traded on the stock exchange in much the same way as stocks, and generally backed by the physical asset. The rise in ETFs has been exponential in the last few years, which has led to additional buying in the base commodity, adding further demand issues to the market.

However, ETFs provide us with a rich vein of information about the commodity markets, and indeed is one of the many instruments we analyse when looking for clues and signals in related markets. To put this into context, gold and gold related ETFs now account for almost 10% of the physical bullion held, and only surpassed by the US, Germany, the IMM fund, France, Italy and Switzerland. This gives you some idea of the growing importance not only of ETFs as a trading instrument, but also of their impact on gold and gold prices in general.

Where and how do we track commodities in the market? The good news is it is possible in many different ways and all relatively easily. The most common way and, generally free is using the spot market price, for commodities such as gold, oil and silver.

The futures market is another excellent source, but remember these are prices for the commodity at some future price, and will therefore differ from the spot price which is the live current price for cash exchange in the market.

Live or slightly delayed futures prices are now becoming increasingly available and also free, so if you do not have a futures feed, or futures brokerage account, this is not a problem. Again the resources section will help you find free sources for all this data.

In case you were wondering, and before we start looking at individual commodities, whether there is any direct link between commodities and currencies, the short answer is, yes. Several currencies are often referred to as commodity dollars. These are the Canadian dollar, the Australian dollar and the New Zealand dollar.

The reason is simple. These are countries whose economies and exports are closely linked to commodities due to their rich reserves of natural resources, which is yet a further reason for having a deeper understanding of commodities and the role they play.

But let's start with a simple example and examine the relationship between gold and the US dollar, as this epitomises the two extremes of money.

Both are considered safe haven, with gold having the added benefit of being a hedge against inflation. In addition, the price of gold is also influenced by buying demand, particularly from India and China.

India has its own gold buying 'season' which typically starts in early October and runs to the end of the calendar year, which is often reflected in the price of gold. With jewellery making up almost 70% of the world's gold demand, India is at the top of the list, even more so recently with the surge in the middle classes.

China too, is adding its own weight to demand for the precious metal, and in 2012 Chinese citizens are now permitted to invest in gold directly for the first time in history. Both these countries now have a relentless appetite for gold which is increasing all the time. And China recently announced it too would be launching an ETF backed with physical gold.

Second, gold provides the bridge between money and all the other markets as the purest of all commodities, and it is a direct relationship, since gold, like almost all other commodities, is priced in US dollars. As a result, a trend change in one, will almost certainly have a direct and immediate trend change on the other.

When we consider other relationships between the various capital markets this is rarely the case, and we need some sort of bridge, to analyse the effects of money flow and risk. A linking mechanism if you like between two worlds. Commodity markets are one such bridge, linking the world of money with the economy and market sentiment.

Since the removal of currencies from the gold standard back in the 1970's the text book relationship between gold and the US dollar has been an inverse one, with gold rising on US dollar weakness and conversely, the US dollar strengthening as gold prices fall.

The reason for this is two fold. First, as gold is priced in US dollars, as the currency weakens the gold price rises accordingly and vice-versa. In other words, a weaker dollar allows you to buy more gold for the same number of dollars. Second, it's all to do with inflation.

Inflation is the double edged sword with which economies are managed by the central banks. It is not only a double edged sword, but also an extremely blunt instrument. Furthermore, it is the only instrument the central banks have to create relatively stable and healthy economies which are then conducive to the creation of jobs. Inflation is good, but too much is bad, and inflation is created using another blunt instrument, namely interest rates.

In many ways inflation needs to be like Goldilocks porridge, not too hot and not too cold. Too much and the economy overheats, the brakes are applied too late, and recession ensues. Too little, and no growth occurs.

Inflation also brings with it the erosion of money in real terms, which is where gold steps in as a hedge against inflation. Finally, of course, gold also serves one other purpose – it is the ultimate safe haven for money in times of economic uncertainty or turmoil in the markets.

But for the time being, let's just concentrate on the relationship between the US dollar and the price of gold. Now, wouldn't it be great if this relationship could be relied on at all times? Well, sadly it can't, and like many other cross market relationships, these can and do break down from time to time. And whilst the inverse relationship between gold and the US dollar is a strong one, it is not infallible, as is shown in Fig 3.10

Let's take a step back, to the start of the sub prime mortgage crisis, which saw an avalanche of banks and mortgage companies collapse, both in the US and elsewhere. This was swiftly followed by a world wide recession (if not depression), sovereign debt defaults in Europe, and historically low interest rates in most of the Western world.

Throughout this period, the gold/dollar relationship was punctuated with periods where gold and the US dollar moved higher, or both moved lower, with a consequent return to the inverse relationship shortly after. This is shown on the chart in Fig 3.11 from November 2009 to March 2011.

In other words the relationship had moved from an inverse correlation to a direct positive correlation over this period. And the question is why, given that shortly after in September that year, the relationship reverted to normal, with gold rising and the US dollar falling, a relationship that has remained intact since.

Early in 2010, the sovereign debt issues in Europe began to surface. Countries such as Greece, Portugal and Ireland, and latterly Spain (all referred to as the PIGS) flagged to the markets they were in severe financial difficulty.

The prospect of default in an EU member state was a real possibility, and without support from the European Central Bank, even more likely. This was not something the EU or ECB could even consider.

The markets reacted negatively to the news, selling the Euro and buying the US dollar, the safe haven currency, and sending the US dollar higher as a result. BUT, in addition, investors also bought gold as the ultimate safe haven, pushing the price of gold higher, along with the US dollar. This buying of both assets continued into the early summer, at which point the US economic picture began to dominate, with the Federal Reserve hinting at a further round of quantitative easing.

This policy, it was hoped, would stimulate the economy by creating an environment for growth and so drive inflation into the system, but also ensure the US dollar fell, thereby making exports cheaper. Cheaper exports would help US companies with overseas operations improving their profitability as a result.

With the issues in Europe now apparently resolved, investors moved back into the Euro, a high risk currency, temporarily selling both gold and the US dollar. This continued for two months in July and August. However, once the full extent of the FED policy was unveiled, the money flow was back into gold, and away from the US dollar for two distinct reasons.

First, the threat of inflation had now been raised by the FED policy, with gold becoming the safe haven hedge. Secondly, and in tandem, the US dollar was no longer seen by the markets and investors as safe haven, given the number of dollars now being created. Gold was seen both as the safe haven and also as a hedge against the possible inflation that was likely to follow the FED policy.

The above is a very simple example of how domestic and international markets affect the flow of money between these two safe havens. More importantly, it is also an example of how a relationship between one asset and another, no matter how strong, can and does change. This does not invalidate the relationship, it is simply a recognition of the fact markets are driven by people and their money.

On this occasion, investors initially considered both the US dollar and gold as safe havens, as they moved out of the Euro and into these safer assets. Once the FED policy had been signalled to the markets, investors decided gold was the safer bet, and not the US dollar, reinstating the traditional inverse relationship once more.

This is why relational analysis is so powerful, provided you know where to look and how to analyse what the chart is saying. Key here is an understanding of the fundamental picture behind the chart, and again this is so important to understand, and will be covered in detail later in the book.

Of course, as forex traders, the US dollar is central, and if we know where the dollar is heading, this will be reflected in all the major pairs directly. Whether the money flow is in or out, whether it is safe haven buying or selling for higher risk assets, or whether it is selling to find a safer haven, as in the example above, this can all be revealed by looking at gold, and its relationship to the US dollar. Provided of course you also understand the other drivers for gold, such as inflation and safe haven status.

As we can see from the chart in Fig 3.10, the relationship has now returned to the normal inverse. Gold moves higher and the US dollar moves lower, and vice-versa. But remember, there are other forces at work in this relationship which are likely to increase in importance as we begin to move out of recession and into a phase of early expansion, where inflation and interest rates will once again start to play a more dominant role.

In summary, the gold to US dollar relationship is pivotal and provides a bridge between two capital markets, linking two safe haven asset classes. It is an extremely sensitive relationship, with a change in one almost instantly reflected with a change in the other.

The Australian dollar has been underpinned by soaring prices in a variety of commodities, including gold, copper, iron ore and aluminium. In addition, and just like New Zealand, the economy is underpinned with soft commodities which have helped Australia weather the global economic storm, better than most.

With China as its largest trading partner, demand for base commodities and precious metals remains strong, despite the recent slow down, and this has all been reflected in a strong Australian currency, particularly against the US dollar and the Japanese Yen. The association with commodities is also reflected in the AUD in terms of risk appetite and, as we will see later, the AUD/USD has also seen a close correlation with equity markets as a result.

Another currency closely associated with gold is the South African Rand, and although the country remains the largest gold producer in the world, production is now falling, and the close relationship that once existed between the Rand and the price of gold is now breaking down as a result.

The problem for much of South Africa's declining industry is the shortage of power in the country, which has led to many mines simply closing or being moth balled, thus preventing exploitation of growing demand for gold. This has been reflected in the Rand which has remained weak having sold off from the highs of 2002, and in sharp contrast to the Australian dollar.

Let's turn to another key commodity and that's oil, and there are three things we can say about oil with complete confidence.

First oil will eventually run out. Second, those countries that have it will demand ever higher prices for this precious commodity. Third and, perhaps most importantly, it is the only commodity which is subject to a legal and legitimate cartel called OPEC, which controls supply in order to protect its oil rich member states.

Until this point the price of oil had been governed by the gold standard. At the time the price of gold was set at $35 per ounce, with oil prices stable at around $3 per barrel. However, when Richard Nixon shut the gold window, in effect refusing to pay out in gold to those countries holding the US dollar, these oil producing countries were forced to convert their excess US dollars into gold in the open market. The effect was to drive gold and oil prices higher and the US dollar lower.

This came as a shock to oil producers, who were suddenly faced with receiving a weak currency for their oil instead of gold. In two years from 1971 to 1973, the US dollar index lost almost 25% of its value, at which point OPEC was forced to act. An oil embargo was introduced against supporters of Israel during the Arab Israeli war, which sent oil prices soaring above $12 per barrel and in one short war, achieving OPEC’s objective of quadrupling oil prices in two years.

In 1975 OPEC agreed to sell its oil exclusively for US dollars, in effect confirming the US dollar as the world's currency of first reserve, which is where we are today.

Now first and foremost, increasing oil prices will fuel inflation – they have to, it's as simple as that, and ultimately of course inflation will mean one thing in the longer term. Higher interest rates. However, for OPEC it’s not that simple.

The group is composed of many different countries, all with different cultures, agendas and political objectives. So they rarely, if ever, agree and any production quotas which are agreed are rarely adhered to, generally to the annoyance of other OPEC members.

It is also the only commodity, other than gold which is unique, in that it is not governed by the simple rules of supply and demand. The supply of oil is controlled, and therefore the price of oil is not one of a free market of price discovery.

For oil producers with higher prices comes the threat of inflation and higher interest rates, which in turn may lead to a slow down in demand for oil, and coupled with erosion from inflation, leads to higher extraction and production costs.

As I mentioned at the start, the switch from the gold standard to the US dollar, left oil producers with a great deal of bad feeling towards the US government, and by extension, the US dollar.

Ever since, there has been talk of removing the US dollar and replacing it with an alternative. This now seems a real possibility following a series of secret meetings in 2009 between the Gulf states, China, Japan, Russia and Brazil. These were followed in both 2010 and 2011, with further meetings with finance ministers, to put together plans to price oil against a basket of currencies. These included the Chinese Yuan, the Japanese Yen, the Euro, and of course gold, along with a proposed 'unified' currency from the Gulf states.

Such a move would have a profound effect on world currency markets, as well as global economic stability, and it is not too fanciful to suggest we are almost sure to see an economic war in the future, between the US and China, over Middle East oil, in the next ten years.

It is probably no great surprise that Saudi Arabia grabs the top spot with almost 20% of the world's supply, but the second largest may surprise you. This is Canada with almost 14%, and just like Australia, Canada’s rich natural resources have helped the country to survive the worst excesses of the global meltdown.

It is therefore no great surprise to learn that oil and the Canadian dollar have a close relationship, along with the Norwegian krona, the Russian ruble and the Mexican peso.

The Canadian dollar is generally referred to as one of a group denoted as 'commodity dollars' which include the Australian dollar and the New Zealand dollar. In terms of export market, the US is its largest and nearest trading partner, and absorbs almost 80% of its total exports, and a massive 90% of its oil.

It's no surprise therefore to see this simple relationship in action every day in the USDCAD currency pair (affectionately known as the Loonie), with rising oil prices leading to strength in the Canadian dollar and a consequent fall in the US dollar. Whilst falling oil prices lead to weakness in the Canadian dollar and a rise in the pair.

Of course, the US and Canada are neighbours and given my earlier comments about the political uncertainty in the Middle East, and a likely economic war with China, coupled with the fact the US is the world's largest consumer, importing oil from Canada seems infinitely more attractive than from the Middle East or elsewhere. It is no surprise therefore to see China also courting Canada in order to supply its own burgeoning demands.

Fig 3.12 shows the daily price action for the WTI oil futures contract above, and the USD/CAD currency pair below. As you can see, as the oil price changes, either higher or lower, the USD/CAD pair moves in the opposite direction. In other words the relationship is inverse as the Canadian dollar is the counter currency, so as the oil price falls the USD/CAD rises.

Canada's oil reserves are in the region of 200 billion barrels, second only to Saudi Arabia, and representing almost 15% of the world's total reserves. Much of Canada’s oil is in the form of bitumen oil, and located in the vast Alberta sands oil fields. These are now increasingly significant as the growth of alternative sources gathers momentum and begins to challenge conventional supplies, and creating yet more problems for OPEC. Keep prices low to drive out competition, and upset the members, or allow prices to climb which encourages more alternative suppliers to enter the market with lower costs of extraction.

Extraction and refining this oil is expensive but falling all the time, and as more traditional reservoirs run dry, the Alberta sands oil fields will take on ever increasing significance. All of this makes the Canadian dollar extremely sensitive to changes in the price of crude oil.

The same is also true for the Norwegian Krona (NOK). Norway is the world's third largest exporter of crude oil, behind Russia and Saudi Arabia and, in addition, also has the same ranking for natural gas.

Just like Canada, and other commodity related currency countries, Norway has weathered the financial storm extremely well, with surging oil prices helping to push up the country's trade surplus to 16% of GDP, the second highest in the industrialised world after Switzerland.

Here in Fig 3.13 we again see a similar picture to the Canadian dollar. Once again the counter currency is the Norwegian Krona, so as the price of oil rises, the USD/NOK falls, and vice-versa.

The question here from a currency trading perspective is given the similarities and correlations with oil, which of the two currency pairs would you select to trade, all things being equal, based on the oil price? And the answer to this question lies in the export markets.

Canada's exports are very closely associated with its nearest neighbour, the United States. Norway's exports are dominated by the European markets, who absorb over 80% with the UK and Germany taking the lion's share. Canada's export market is primarily the US, so any economic slowdown here will be reflected more strongly in the USD/CAD.

As I mentioned earlier there are several other currencies which have a close relationship with oil. These include the Russian ruble, the Mexican peso and the Brazilian real. Of these perhaps the most interesting for the future is the last of these, the Brazilian real with not only new and exciting oil reserves being discovered, but also with a strong and growing market in ethanol extracted from sugar cane. With the world demanding ever cleaner energy sources, Brazil is well placed to benefit from this increasing demand over the next few decades.

Having considered oil producers and world oil reserves, we now need to consider the consumer end of the equation, and as you would expect, at the top of the list are the USA and China in that order. Between them they account for almost 35% of the world's total consumption of oil. In third place is Japan which, unlike China and the US, has to import virtually all of its oil, along with every other commodity. Indeed following the tsunami which destroyed several nuclear reactors at the Fukushima plant, Japan has become even more reliant on oil as it struggles to recover, with the anti nuclear lobby now adding its own voice.

As a result, the Japanese economy and the Yen are very sensitive to changes in the price of oil, and this is reflected in the Canadian dollar, Japanese yen currency pair as shown in the chart in Fig 3.14.

In this case, the counter currency is the Japanese yen, so the CAD/JPY has a direct and positive correlation. As the price of oil rises, the CAD/JPY also rises in step, as the Canadian dollar strengthens accordingly. Conversely, any fall will see the pair sell off.

Whilst this relationship is partially driven by the Canadian dollar and the movement of the oil price, the Japanese yen is driven in this pair by the economy which is so reliant on the commodity as an import, which is therefore likely to result in higher costs and prices. This in turn drives inflation with the prospect of higher interest rates as a result.

Until 2009, the de facto benchmark for oil prices was the WTI or West Texas Intermediate crude oil future, which is based on the price at the physical delivery point in Cushing, the oil hub in Oklahoma.

However in the same year, the Saudis decided that they would no longer price their oil using the WTI oil contract, but instead use the ASCI which stands for the Argus Sour Crude Index. There were many reasons for this, not least because of the inventory problems at Cushing which has a huge impact on the price of oil, and this is covered later in the fundamental section of this book.

The oil fundamentals are released each week in the weekly oil inventory figures, which in simple terms show whether oil is in demand, reflected in a fall in inventories, or demand is falling with an increase in inventories.

The Saudis became frustrated at the constant price volatility each week, due to this false mechanism of measuring supply and demand, and consequently moved to the new index. This is yet another example of how political oil is as a commodity, and this has much to do with the break-even point for production. In other words the point at which oil becomes uneconomic to extract and refine.

For the Saudis, they like to see a minimum of around $88 per barrel to maintain a healthy profit. For Canada, the break-even for the Alberta Sands oil is around $60 per barrel and indeed when oil was trading at this level for some time, all extraction was suspended, and sites closed down ahead of a recovery in the price of oil.

Having looked at oil in detail let's now consider another of the key commodities, copper, and its relationship, both in the broad markets and more particularly to currencies.

If oil is one of those commodities forex traders rarely consider, copper is one they probably never even think about, and yet, just like oil, it is a bellwether commodity, which tells us a great deal about the economic picture, and therefore money flow, risk and market sentiment.

Copper is also interesting for another reason. It is an example of where one relationship which worked in the past, has since broken down, to be replaced by another. Relational analysis, like all trading is an art, not a science. Relationships do hold well for extended periods, but just as we saw with gold and the US dollar, sometimes these relationships disengage, only to re-engage later.

The key point is this. No relationship between markets can ever be considered as either guaranteed or perfect. They can and do change, and are simply there to give us an alternative view with which to quantify risk, which is what this book is all about.

So where to start with copper, or Dr Copper as it is referred to by traders, as well as being known as the red metal? If gold is the ultimate hedge against inflation, copper is the most sought after metal for all forms of economic activity as it is widely used in manufacturing, construction, and in the electrical sector, where its applications are both diverse and varied.

As a result, copper has always been considered a leading indicator of economic growth, with rising prices signalling increasing demand which in turn suggest economic growth and rising inflation.

Until 2008, the relationship all traders used to watch was between copper prices and the London Metals Exchange or the LME. Stockpile levels were monitored closely, providing traders with a view of the balance of true supply and demand, as these were held for physical delivery against futures contacts and, at the time, proved to be an extremely reliable indicator of future prices for the metal. This was largely due to the LME's ability to track the collective inventory of its global network from its warehouses on a real-time basis.

In other words, this information was up to date and not delayed and offered traders a unique fundamental view of the above ground supply of copper. Mined copper is normally shipped direct to the customer and the volumes flowing through the LME warehouses were relatively insignificant as far as global trade was concerned, but the stockpile levels played a vital role in giving traders a view on the true balance of supply and demand in the market.

Put simply, if customers couldn't get enough of the metal from their regular supplies, the LME stockpile was used to supplement this extra demand. Therefore, from a trading perspective, if the LME stockpile fell, copper prices were expected to rise and conversely, if the stockpile fell then copper prices were likely to fall.

All of this changed, suddenly and dramatically as the financial crisis exploded, when as panic engulfed the stock markets and the entire global economy, a radical shift in base metals took place. Demand growth quickly slowed and then shifted into decline and, as a result, supply quickly caught up and the supply deficient imbalance all but disappeared overnight.

The old relationship broke down completely but was replaced by a new and interesting one, this time with the S&P 500. This began in 2009 and has continued ever since. As copper prices have moved higher, so has the S&P 500, and consequently falling as the index falls. A classic example of how linkages between markets can and do change, and on this occasion the catalyst for change was the financial crisis and subsequent sell-off in the equity markets.

However, there is a further factor with copper, and that is China. China is the world's largest consumer of copper and this is where we have to be careful in any analysis, for the simple reason that since 2002, China's exponential growth has masked any slowdown in the world economy.

First, with so much of the copper supply consumed by one country, and set to increase, this can distort the true picture. Second, over the last few years there have been continuing supply problems, particularly in Chile, the world's largest exporter of copper, which represents almost 55% of its total exports. China’s domination of the commodity looks set to continue for some time to come for the following reasons.

First, China needs this commodity to build its infrastructure, particularly its aged and faltering power grid system and telecoms network. Both massive projects. Second, China is now stockpiling copper as a hedge against inflation and the damaging impact the FED is having on China's huge US dollar reserves, which will increasingly become devalued as the US dollar weakens and inflation takes hold.

Copper is seen by the Chinese as a physical hedge in much the same way as for gold or silver, and this change in dynamic is yet another reason to watch the price of copper carefully and not just as a commodity, but as a tangible asset. This is all part of the Chinese plan to move away from its dependency on US Treasuries and into more tangible assets such as copper.

In an effort to corner the market, China has been aggressively buying its own mines overseas as well as stockpiling on a grand scale. All this has driven up copper prices, but not in the conventional supply driven way.

Nevertheless, copper remains an important commodity for many reasons, not least giving us an insight into the possible future market direction for equities, risk assets, and inflation. This linkage may breakdown in the future, but for the time being it remains yet another simple and visual way to gauge money flow and risk sentiment. If copper prices are rising, risk on assets will be rising in tandem, which in turn will be reflected in risk currencies.

One of the major beneficiaries over the last few years has been the Australian dollar once again. The Australian dollar’s correlation to commodity prices continues to remain strong across the board and not least as far as copper is concerned. China is Australia's largest trading partner and is responsible for more than half the country's shipments of copper, iron ore and other base metals, and should the Chinese economy slow or reverse, this will be reflected in the Australian dollar as a result. The currency can therefore be considered in two ways.

First, it can be looked at through the prism of the commodity market, and therefore as a proxy for risk, since commodities are considered to be risk assets. Second, it can be viewed in its own right as a currency driven by demand for commodities, and in particular base metals such as copper, a view which can then be validated against the US dollar.

Another currency to benefit from the last ten years in the commodity super-cycle is the Peruvian Neuvo Sol, an emerging exotic currency. Peru is the world's second largest exporter of copper, and with the Peruvian government now granting additional licences for mining, the country is set for economic growth and a strong currency based on the red metal.

As forex traders, commodities provide the bridge, with many complex linkages between the four principal capital markets. These relationships are seen in many different ways and reveal many different facets of market behaviour, from the global economic picture, to risk, to money flow, and market sentiment.

However, nothing is ever clear cut, and with the inexorable rise of China, simple analysis must always be tempered with the 'Chinese factor' upper most in our minds. China is a huge and voracious country, which not only drives explosive demand, economic growth and prices, but could also lead to equally dramatic falls in the future. All this will be played out in the commodities market, and reflected in currencies, which are the mirror against which all market behaviour is ultimately reflected.