Intermarket relationships can often help when analyzing trend directions in currency pairs. For example, Canada, as an oil exporter, will tend to see its currency follow the price of oil. As the price of oil increases, so does the value of the Canadian dollar—especially against the United States, which purchases the majority of Canada’s exported oil.
The U.S. dollar also tends to follow oil closely. For it, however, the dollar tends to fall as oil prices rise. Since oil is denominated in U.S. dollars, when the dollar gets weak, producers will be inclined to raise prices to compensate for the lower dollar revenues. Higher oil tends to slow the U.S. economy, which should be bearish for its currency.
Another recent intermarket relationship has been between the U.S. stock market and the dollar. As the market has fallen in value, the dollar has gotten stronger. One theory behind the relationship is that what’s bad for the U.S. is worse for other countries. Though this isn’t likely to be a truism forever, if an intermarket relationship works consistently over a period of time, traders will begin to follow the pattern and make it a self-fulfilling prophesy—for a period, at least.
One of the more reliable and positively correlated intermarket relationships is the Australian dollar versus the price of commodities. As the prices of commodities rise, so does the value of the Australian dollar, and visa versa.
Australia’s Economy at a Glance
Australia is about the size of the U.S., but with 21 million people, it holds a fraction of the population. What the country lacks in population, it makes up with an abundance of natural resources. Australia mines a number of minerals including coal, iron ore, gold, bauxite, copper, tin, silver, uranium, nickel, tungsten, lead, zinc, and diamonds.
Though it imports oil and petroleum products, it also produces its own natural gas and petroleum for consumption. The agriculture products it harvests include wheat, barley, sugarcane, fruits and its livestock includes cattle, sheep, and poultry. Its coal production is the largest in the world—supplying 29% of the world’s supply of coal.
Australia’s abundance of resources for consumption and industry has been beneficial. During World War I and World War II, the British relied on its industrial natural resources for the production of wartime weaponry, which was instrumental to the outcome of both wars.
Commodities and the Australian Dollar
From 2001 to 2008, Australia enjoyed a high, consistent growth rate. From the first quarter of 2001 to the third quarter of 2008, the economy had a record 31 uninterrupted quarters of growth. The global economic decline has broken that string, with fourth quarter growth showing a decline of 0.5%.
The Australian growth was largely helped by a surge in commodity prices and exports. The exports went to a number of less developed countries that have been modernizing their infrastructure and are in relatively close proximity to Australia. As a group, these countries needed a lot of raw materials to build.
For example, Australian monthly exports to China have increased at a torrid pace since 2000, growing by nearly 800%. Its exports to India, another high-growth country, increased by 1,523% from January 2000 to September 2008 before falling sharply to a 668% increase in January 2009.
As the global demand for commodities rose during 2007 to 2008 due to the modernization surge, the prices of commodities likewise rose strongly. From September 2007 to July 2008, the Commodity Research Bureau Index moved from 301 to a peak of 473. During this period, the geographic proximity of Australia to the high-growth areas like China and India led to a surge in its exports of industrial and mining commodities like steel, iron, copper, and coal.
As exports surged, Australia’s economy grew, employment soared, and inflation pressures rose. This resulted in a rise in interest rates to 7.25%, the highest rate since 1996. As interest rates increased, the value of the AUD/USD rose (see blue line in chart).
In July 2008, the value of commodities peaked and started to unravel. Demand slowed for raw materials on a global basis, prices started to fall, exports to high-growth areas fell sharply, and the value of the Australian dollar also fell as unemployment started to increase, inflation slowed, and the growth rate in Australia turned negative for the first time since 2001. Interest rates were lowered (currently at 3.5%) and the AUD/USD currency rate fell sharply.
Commodities Are Key in Australia
Most analysts are in agreement that Australia’s geographic proximity to potentially high-growth areas and its abundance of natural resources is a relative advantage when the time is right. When global growth slows and commodities prices fall, the potential disappears—and the decline can be fast and furious. By watching the prices of commodities, the clue to the Australian dollar’s direction will fall into place.
Writer's Bio
Greg Michalowski is chief foreign exchange and economic analyst for FXDD, an online foreign exchange liquidity provider for retail traders and investment managers.
For daily market commentary on the foreign exchange market, visit http://forex.fxdd.com or contact Michalowski at greg@fxdd.com.
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