By Gary Dorsch (
Global Money Trends
With the Sword of Damocles hanging over the euro currency by a
thread, many speculators in the foreign exchange markets are
flocking to the currency Down Under - the Australian dollar,
attracted to its free wheeling and dealing, and its heightened
volatility. The Aussie dollar offers much higher interest rates
than other Asian currencies, such as the Hong Kong dollar and
Japanese yen, whose exchange rates are essentially fixed by their
governments though daily market intervention, making the Aussie a
favorite target for carry traders.
The Australian dollar is the fifth-most-actively traded currency
in the foreign exchange markets behind the U.S.-dollar, the euro,
Japan's yen and the British pound. The Australian dollar now
accounts for 7.5% of the turnover in the $4-trillion-a-day currency
market, and it's gaining popularity, because the Australian central
bank keeps its intervention in the currency markets to a minimum.
Most of all, its direction is linked to the commodity super cycle,
and offers indirect exposure to the world's fastest growing region
in Asia, especially China.
Australia's mining boom is largely fueled by Chinese demand,
which has kept Australia's economy out of recession for the past
20-years. "It is likely to be sustained for a very long period,"
Prime Minister Julia Gillard said on October 3rd. "We are in a
different economic phase and we shouldn't let the language of boom
deceiveus. It is a boom, it is a huge opportunity for growth in our
resource sector and great opportunities for jobs and wealth
creation as a result, but it is likely to be sustained for a very
long period of time," Gillard said.
(Click to enlarge)
As is often the case with countries that rely on commodities for
a sizable percentage of their exports, the direction of the
Australian dollar is closely correlated to the gyrations of key
commodityprices. Yet interestingly enough, Australia's top-2 export
earners, coal and iron ore aren't included in the basket of
commodities that are traded in the European or U.S. exchanges.
Still, Australia is blessed with wealth of natural resources that
are in high demand, including crude oil, gold, grains, diamonds,
iron ore, uranium, nickel and coal. Among the Group-of-20
countries, Australia stands out with mining, energy, and
agricultural commodity exports accounting for around 12% of the
GDP, but 60% of its total exports.
Generally speaking, sharply higher commodity prices can fuel
strong inflationary pressures in most Emerging economies, and prod
central banks to lift interest rates. At the same time, sharply
higher commodity prices will zap the disposable income of consumers
and whittle away at the profitability of producers in the developed
nations, such as in Europe, Japan, and the United States. Yet the
Australian economy usually looks healthier when commodity prices
are rising. That positions the Australian dollar, dubbed the
"Aussie," as a popular alternative to the euro, Japanese yen,
British pound, and U.S.-dollar for traders looking to go long on
commodity exposure, while going short on currencies whose local
companies are likely to suffer weaker profit margins due to higher
(Click to enlarge)
High prices for industrial commodities, especially base metals,
iron ore, coal, and natural gas are now providing Australia with
its largest trade surpluses in history. Australia posted a trade
surplus of $3.1-billion in August, - the second highest on record.
That brought the running 12-month total to a healthy
A$22-billion.In particular, the industrialization and urbanization
of billions in China and India is generating huge demand for coal
and iron ore, Australia's two biggest exports. Over two-thirds of
Australia's exports now go to Asia, with China alone accounting for
26% of total exports, while the EU takes 7% and the U.S. less than
Overall, Australia's miners and farmers are tipped to drive
export earnings to new heights this fiscal year, assuming that
commodity prices can defy the doom and gloom in the global
financial markets. Export receipts from mines, gas and oilfields
will surge past the A$215-billion mark for the first time in
2011-12, with farms adding another A$35-billion to the export
tally, despite the high local dollar."The +21% increase in
resources and energy export earnings reflects strong increases for
most commodities, including coal, iron ore, crude oil and natural
gas, base metals and gold," the Bureau of Resources and Energy
Chinese demand for commodities looks to have remained resilient
in August, even as global stock markets nosedived. China's imports
from Australia rose almost +42% in August from a year earlier to a
record $6.6-billion. China ran a trade deficit with Australia worth
$4.3-billion for the month. That demand helped lift the RBA's index
of commodity prices to record peaks both July and August, having
climbed +25% over the preceding 12-months. Exports to Japan were
ahead +7% at nearly $5-billion, while shipments to Korea climbed
+14% to more than $2 billion. For the 12-months to August, exports
to East Asia rose +26%, with shipments to China reaching a
cumulative A$64.8-billion, and up an astonishing +33-percent.
Overall, Australian exports to China have increased 25-fold in real
terms since 1990.
The boom in commodity exports helped to lift the Australian
dollar above parity with the U.S.-dollar on October 15th, 2010 for
the first time since becoming a freely traded currency in 1983. The
Aussie then traded above parity for several days in November. On
May 2nd, 2011 the Australian dollar hit a record high when it
traded at a $1.1011 against the U.S. dollar. Seeking to head off
inflationary pressures, the Reserve Bank of Australia ((
)) has kept its overnight cash rate locked at 4.75% for almost a
year, a neutral level that neither stimulates nor retards economic
growth, while a strong Aussie dollar also helps keep inflation in
Australia is also the world's single-largest exporter of the
iron ore. Roughly 62% of Australia's exports to China are
concentrated in sales of iron ore, and 7.5% in coking and thermal
coal. Thus, roughly 70% of Australia's total exports to China, -
coal and iron ore, - are directly linked to China's vast
steelmaking industry, which produces half of the world's steel
output. To meet China's voracious demand, the Australian Bureau of
Agricultural and Natural Resources is projecting iron ore exports,
the biggest earner, to jump +5% to 425-million tons in 2011, and
could reach 600-million tons by 2016. Some of Australia's biggest
customers are Baoshan Iron & Steel, China's biggest publicly
traded steelmaker, Sumitomo Metal Industries (SMMLF.PK), Japan's
third-largest steelmaker, and India's Tata Steel (TATLY.PK).
Rio Tinto (
) is the world's #2 iron ore producer by volume after Vale. In the
next five years, Rio plans to grow output by +50% to 333-million
tons a year in Australia's western Pilbara region, at a possible
cost of more than $15-billion. Rio reported a first-half profit of
$7.8-billion and declared it would step up its share buyback by
$2-billion after a cash windfall from record commodity prices.
Melbourne-based rival BHP Billiton (
) produced Australia's largest-ever annual corporate profit of
$21.7-billion and operating cash flow of $30.1-billion.
Income from iron ore, BHP's biggest division, rose a better than
expected 122% to $13.3-billion last year, spurred by strong demand
from Chinese steel producers. The story was the same in other
divisions. Earnings from base metals soared +47% to $6.8-billion.
Profits from oil grew +38% to $6.3-billion. BHP Billiton is also
investing billions in new production capacity in iron ore and coal
in Australia, and completed a $10-billion share buyback ahead of
schedule. Fortescue Metals Group was also rewarded with a healthy
profit courtesy of soaring iron ore prices and increased
production, with a +76% jump in annual profit, to $US1-billion.
In fact, BHP Billiton's $22-billion profit was equal to nearly a
third of the total $71.4-billion in profits reported by Australia
companies this earnings season. Throw in Commonwealth Bank's
$6.4-billion profit, and the two companies -- with a combined 20%
index weighting -- produced 40% of the reported profits. However,
despite all of these glowing results, the Australia Stock
Exchange's metal miners' index has been sliding down a slippery
slope, since April 11th and has lost as much as -31% of its market
The selloff in Australian mining shares began to accelerate in
July, and in sympathy, knocked the Aussie dollar from its high
perch at $1.100 to below parity against the US$. Currency traders
started to take notice of the most actively traded steel rebar
contract on the Shanghai Futures Exchange, which began tumbling
from as high as 5,400-yuan /ton, to as low as 4,205 yuan /ton this
week, after dropping more than -11% in September, its biggest
monthly loss ever. Traders say that a construction boom in China
that fuelled steel prices higher earlier in the year is starting to
lose steam, as a result of tighter credit conditions.
Prices for iron ore, the key component in making steel, has also
tumbled by more than -12% since August 28th, amid expectations that
#1 buyer China might cut its steel output in the fourth quarter.
Index-based spot iron ore prices, based on Chinese transactions and
used by global miners in fixing supply contracts, slid to $153.45
/ton on October 17th, the lowest since March. Prices of forward
swaps also extended losses, with the Singapore Exchange-cleared
November contract falling more than $4 to $154.17 /ton.
Chinese steel output fell to 56.7-million tons in September,
falling from a record high of 60.2-million tons in May. Although
output in September was still +16.5% higher than the same period of
last year, traders in Shanghai figure that steel output has reached
a peak and expect further declines in the fourth quarter, normally
a peak demand period, with steel mills impacted by a slowdown in
the global economy as well as domestically.
Australia is also the world's biggest exporter of coal, shipping
about 316-million tons annually, and worth roughly A$46-billion in
overseas sales last year. Australia's coking coal exports are
estimated at 164-million tons this year, equal to nearly 60% of the
global total. China single-handedly produces about half of the
world's steel, and coking coal has quickly emerged as one of the
handful of commodities in critical need by its steel sector. In
2009, China became a net importer of coal for the first time. It
bought 104-million metric tons of coal, including both thermal coal
- used to fire power plants for generating electricity, and coking
coal. China's coal imports for the first nine months of this year
reached 120-million tons.
(Click to enlarge)
However, the price of thermal coal, accounting for about half of
Australia's coal exports, and in more abundant supply in China, is
starting to slide alongside the stumbling price of iron ore.
Fortescue Metals predicts iron ore prices are likely to continue
sliding in the months ahead, even after the company released solid
first-quarter results. Fortescue's iron ore fetched an average
price of $US160 /ton during the three months to September, but it
now sees "softening steel prices and a tight monetary policy in
China helping to bring iron ore prices down, and would continue to
do so." In a positive note for Fortescue, its costs of production
were lowered to below $US50 /ton for the first time.
Thermal coal at Newcastle, Asia's benchmark price, tumbled to
$117.50 /ton this week. That's down from a three-year high of
$131.50 /ton last January, when floods inundated Australia's state
of Queensland. Indonesia's coal output may rise 6% to a record
340-million tons this year, and supplies from Australia are
expected to increase +12% to 135-million tons in 2012. Thus,
traders now suspect that a small glut of thermal coal in Asia could
start to develop.
Copper, the metal with a PhD. in Economics lost as much as a
third of its value from its record high peak, since August 7th. On
Oct 3rd, JP-Morgan reported that the Global Manufacturing PMI had
contracted worldwide for the first time in over two years last
month as incoming orders for new work dried up. Softening prices
for industrial commodities are starting to take some of the wind
out of the sails of the Australian dollar, and are presenting some
formidable headwinds that are weighing on the Aussie's exchange
rate with the U.S.-dollar.
(Click to enlarge)
The Aussie dollar also faces stiff resistance on the interest
rate front, although a rate cut by the RBA wouldn't be taken as a
big surprise by currency trades. The yield on Australia's 1-year
T-bill rate has dropped sharply since May 1st, and is last seen at
4.02%, or nearly three-quarters of a percent below the RBA's
overnight cash rate. Interbank futures on the ASX continue to imply
a two-in-three chance of a 25-basis point rate cut to 4.50% before
year's end. The RBA seemed to open the door for a small rate cut,
as early as next month in what would mark an about-face for the
famously hawkish bank.
The RBA said in releasing the minutes of its October policy
meeting that future decisions would depend largely on the outlook
for domestic prices and on developments in the shaky global
economy. "Members believed that an improved inflation outlook, if
confirmed by further data, would increase the scope for monetary
policy to provide some support to demand, should that prove
necessary," the RBA said. Much would depend on the inflation data
for the third quarter, due on October 26th, falling back to within
the RBA's 2-3% inflation target band. The RBA said it expects
Australia's terms of trade to decline in the period ahead as global
prices for commodity exports eased in response to softening demand
in foreign economies.
Even a modest RBA cut in rates could give a sizable boost to
incomes and provide a direct and rapid stimulus to the economy.
There are A$1.2-trillion of home mortgages outstanding, and95% of
them are based upon variable rates, easily the highest share of any
developednation. This makes monetary policy a very powerful tool.
For an average mortgage of A$300,000, a 25-basis points rate cut
lowers the interest rate expense by A$600 a year.
Two quarter point rate cuts by the RBA, expected by Aussie
T-bill traders could help cap the rise of the Australian dollar,
and might level the local playing field for Australian companies
competing in the global markets. Western Australia is home to the
top miners, and 10% of the country's population, yet is earning
about 60% of the foreignincome. The other 90% of Australians are
earning 40% the foreign exchange. Manufacturing companies trying to
win exports or fend off imports would get some relief from a
slightly weaker Australian dollar.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
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