Commodity currency correlation weakens

Last updated 14:21 14/02/2014

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The formerly strong correlation between commodity prices and currencies of resource-exporting countries such as Australia, Canada and New ­Zealand appears to be weakening.

There is a strong relationship because commodity exports are very important for these countries' trade balances, so a change in commodity prices has a major impact on their terms of trade.

As a result, we should expect a high positive correlation between the value of the Australian dollar, the Canadian dollar, the New Zealand dollar and commodity prices, and this is indeed what we have seen until recently, Nomura currency strategist Martin Whetton said.

"However, correlations have been weakening of late and, in some cases, have even flipped sign. This is contrary to what theory and past experience would suggest, and could provide an opportunity when the relationship between commodity currencies and commodity prices returns to normal," Whetton said.

The clearest divergence is in Canada, where the two have been moving in opposite directions since early November, according to Nomura.

Since 2009 the three-month correlation between the Canadian dollar and a daily version of the Bank of Canada commodity price index has been around 0.5, but it declined to about 0.35 in 2013 and has since continued to decline. It is now close to -0.15.

Similar breakdowns in correlations have occurred, but to a lesser extent, in Australia and New Zealand, where the correlations are about 0.1 and 0.0, respectively, Nomura adds.

"As a result, considering that coal and iron ore prices have declined by about 10 per cent each since the beginning of December, we find that [the Aussie] is slightly overvalued by about 3 per cent using a model linking commodity prices and the currency," Whetton said.

"In the case of New Zealand, ­commodity prices that matter to the country have not moved significantly in recent months, hence we find that [the Kiwi] is about fairly valued ­currently."

The fall of the Australian dollar
In the past 12 months, the Aussie has fallen just under 13 per cent against the greenback, pushed down by a strengthening US dollar and falling commodity prices, amongst other factors.

In the same time, iron ore, Australia's most valuable commodity, has lost 22 per cent of its value and current sits at US$121 ($145) per tonne.

The Australian dollar is buying US90.28¢ ($1.08) and has risen 3.1 per cent in February. In this time, iron ore has ­continued on its downward trend, ­slipping 1.3 per cent.

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Part of the divergence from­ ­commodity prices can be explained by the Reserve Bank of Australia's ­perceived decision to let go of its interest rate easing bias.

"Monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes ­consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates," RBA governor Glenn Stevens said in a statement on the central bank's policy decision.

Stronger than expected inflation data has also boosted the dollar in recent weeks, with markets close to completely pricing out another rate cut.


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