The Reserve Bank of Australia, the country’s central bank, began the third quarter by cutting interest rates by .25 percent. This surprised some market watchers, but perhaps it shouldn’t. The rate decrease came in response to slowing demand for resources in China. And Australia’s economy – and their currency – has largely correlated with commodity performance in recent years.
Australia’s major exports include coal, iron ore, gold and wheat among several other commodities. The drop in rates, and the fall in value for the Australian dollar against the other 16 most-traded currencies comes at the same time that the RBA’s commodity index fell 1.3 percent in September, and 2.8 percent in August.
This kind of correlation between currency and commodities is not unique to Australia, and it’s nothing new.
As my colleague John Labuszewski recently wrote in a paper on commodity currencies:
“As an historical matter, commodity and currency prices have often been closely related. For example, the Deutsch mark was closely correlated with grain prices in the 1970s. The rationale was that the Soviet Union was purchasing grains with funds borrowed from German banks. Similarly, soybean oil was once closely tied to the value of silver because India was buying cooking oils funded with silver reserves.”
Similarly, let’s take a look at Mexico, a country with strong interest in its currency. Its economy is growing with $3.4 billion in foreign investment going into its stock market through July this year, compared to $640 million for all of 2010. The Mexican peso is up 4.5 percent in the last month for the same reason the Aussie is decreasing in value. Mexico’s economy is not as exposed to the slowing Chinese economy. Its main commodities like oil, silver and manufactured goods are mainly traded with the United States or used domestically.
As the commodity situation with Mexico (and China) shifts, more market participants are showing interest in the peso. As of September 18, there were more large open interest holders in our Mexican peso contract than in any other currency except the euro.
The Canadian dollar is also experiencing highs in open interest, with more large open interest holders through September 18 than at any point in the last five years. In Labuszweski’s paper, he measures the correlation of several “commodity currencies” against the S&P GSCI Indices, one of the leading commodity indexes . Canada’s dollar has one of the highest correlations.
This may be because one of Canada’s largest commodity exports, crude oil, has historically had a strong correlation to CAD. That continues now. This summer, Bloomberg’s 30-day correlation coefficient between CAD and crude oil went to its highest level since 1993.
Even with the Eurozone situation determining much of the direction for currencies and economies these days, we have not seen much disconnect in commodity currencies from the resources they are tied to.
For this reason, it’s valuable to look at commodity indexes, but also to markets that allow participants to trade in a liquid cross-section of FX and commodities. That ability is helpful to investors and, as we’re seeing, to economies.
What is a commodity/currency correlation you’re watching?