If prices for iron ore, coal, oil and gold are falling, which they are, how long before the Australian dollar follows?
Probably fairly soon is the correct answer, though it’s a brave speculator who takes a position against Australia’s currency, which has defied intense downward pressure in the past.
This time, however, it might be different, with multiple factors pointing to a substantial drop in the exchange rate against major currencies, including the US dollar, the euro, the UK pound and the Chinese renminbi.
Until recently it was possible to argue that the Australian dollar would defy its critics and ride out the downward pressure, which came with the end of the investment phase of the mining boom, because higher revenue flows would produce a resources-production boom.
A “production-replacing-investment” argument is one that seems attractive and was the reason why I believed until recently that the dollar was more likely to rise than fall over the next few years.
That might still be the case but the weight of evidence, which can be found in the current commodity-price trend, is a worry because:
- Most of the commodities that underpin the Australian economy are in decline.
- The economy is about to cop an overdue “budget broadside” from higher taxes and government spending cuts.
- Consumers are already trimming their spending habits ahead of the May 13 budget.
On the commodity front there is nothing but bad news.
Iron ore, Australia’s biggest single export, has suffered a sharp sell-off because of a Chinese crackdown on its fringe banking sector, where commodities have been used for dodgy financing deals.
Over the past week the price for best-quality iron ore (62 per cent grade and low in impurities) has fallen 5 per cent to $US105 a tonne, unpleasantly close to the important $US100/t mark, which could put financial pressure on some of Australia’s higher-cost miners of lower-grade ore.
Undeterred by the iron ore price slide, the Australian dollar crept up a fraction overnight to be trading just below US93 cents.
Coal, Australia’s second biggest export, has collapsed to multi-year lows, with major producers such as Peabody warning that mines it thought could ride out a price correction are now in danger of closure.
Oil last night dipped below $US100 a barrel in the US because of rising production and, while the US oil price is not yet being reflected in the primary European price, it will be having an effect on the global oil and gas market, including the price of another major Australian export, liquefied natural gas.
Gold, another of Australia’s biggest exports, slipped back below the $US1,300 an ounce mark despite instability in Ukraine.
There are factors other than commodity prices bearing down on the Australian dollar, including concern over both the Chinese and US economies, with China appearing to be weakening (which could dampen demand for Australia’s exports) and the US strengthening (which could push up the value of the US dollar).
Compounding that wall of negative news is concern about the depth of spending cuts likely to emerge in the federal budget and equally deep cuts in state government budgets.
Retailers are pleading with all levels of government to be careful with budget cuts because of the fragile nature of consumer sentiment.
There are reasons for the Australian dollar to remain above US90 cents but they are largely domestic and could easily get blown away by a downturn in the country’s international competitive position.
Near-record lending for housing, which is helping the building sector and boosting banks’ profits, is almost entirely a function of low interest rates.
If interest rates take another haircut, which is possible if consumer sentiment collapses after this month’s expected budget cuts and higher taxes, then the pressure will increase for a corresponding fall in the Australian dollar.
The next few weeks are critical for Australia and its currency. If international investors sense that the weakening commodity outlook and tough budgets are pushing the country to the brink of recession they will head for the exits.