Singapore / Hongkong: Go long commodities, short the dollar", rang the battle cry that pushed oil, copper and wheat to record highs earlier this year.

That trade unwound with fury over the past five months, as the dollar rebounded from record lows and commodities lost 60% or more.

Now the greenback is once again in decline, but analysts say don’t expect that to rekindle interest in an inverse correlation trade that, for some, was dubious to begin with.

“The correlation is broken down here. It shows that this is very much a fundamental story," said Mitul Kotecha, head of global foreign exchange research with Calyon in Hong Kong.

“The demand and supply of oil are overwhelming the overall influence on oil prices at the moment so that Opec has to come up such a drastic cut."

The inverse relationship between the dollar and the broad commodities complex has always claimed a theoretical fundamental basis, as the world’s dollar-based raw materials become more affordable to non-dollar economies as the greenback weakens.

As China and India led a global demand boom, the allure of that link became even stronger, and since 2006, as the sector’s rally began to accelerate, it seemed to be a great excuse to short the dollar and go long copper, oil or grains.

Secular reasons

To be sure there were secular reasons for both legs—the ballooning US trade and budget deficits, and the growth of the euro as an alternative reserve currency, weighed on the dollar; speculative fervour and investment fashion aided commodities.

But in the last several weeks, as expectations for growth in China and India have been sharply scaled back and as tight global credit prevents speculators from re-entering commodity markets, the relationship has largely broken down.

For the moment, the outlook for both is grim. The greenback has lost at least 10% against the euro in the last three weeks. Only the correlation with gold, a quasi-currency that has always claimed the closest link, has remained strong.

“In times of healthy demand, the dollar is a prime driver of prices with close correlations. The problem now is that non-dollar buyers are struggling with their own demand slowdown and the theory doesn’t work any more," says MF Global commodities analyst Edward Meir.

“The weak macro picture will limit rallies in metals. The dollar will get even weaker. Rates are zero and there is a trillion dollar deficit for 2009. It’s hard to make a case for a firm dollar."

The Federal Reserve’s move to cut interest to zero to 0.25% last week looks set to herald another bout of severe dollar weakness against the euro if the European Central Bank maintains its more conservative approach.

Since January 2006 to till date, the gold and dollar daily correlation coefficient, a measure of how much a change in one variable is explained by a change in another, was a very high -0.9. A reading of 1.0 reflects an identical relationship.

Oil and dollar was -0.85 and copper and dollar was -0.6.

Gold: holding steady

But since the dollar index hit a two-year high in November, only gold has held solid at -0.85, and as copper and oil prices have kept on falling and the dollar retreated, the relationship turned positive, with oil at 0.5 and copper at 0.6—meaning the two assets have been moving in lock-step rather than diverging.

For comparison’s sake, between 2001 and 2003, when the global economy was recovering from several big shocks, the gold and dollar correlation was -0.8, oil and dollar -0.6 and copper and dollar -0.2.

For some analysts, the relationship never really existed beyond influencing day-to-day price moves, and the steady rise in commodities until the middle of the year and the dollar’s declines were coincidental rather than causal.

“The emergence of China, India, Brazil and the explosion in demand for industrial raw materials and later the booms in speculation can explain the rise in commodities, without directly linking the two," says an Australia-based analyst.

Xi Chen in Hong Kong contributed to this story.