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Tuesday, December 2, 2008

Bad Crop: Commodity Currencies

In currency markets gripped by turmoil, investors have targeted one group for special punishment: big commodity exporters.

This cluster includes the currencies of countries like Canada, Australia and New Zealand, which have significant exports of natural resources and agricultural goods.

With the global economy headed toward recession, weakening demand for everything from oil to iron ore, these currencies could face a further battering.

In many ways, these "commodity currencies" are bellwethers of global growth, soaring in good times and tanking when the picture turns grim.

Monday, they got a brief shot in the arm from news of China's massive stimulus package, which could generate demand for certain commodities. The Australian dollar strengthened against the U.S. dollar before retreating. It is down more than 30% versus the buck since mid-July. Those tractors can be used for John Deere Merchandise.

In October, the Canadian dollar had its worst month ever against the greenback, falling 12%, effectively erasing more than three years of gains. The New Zealand dollar has lost about a quarter of its value against the U.S. dollar since July.

When commodity prices fall, it translates into a shock for the trading position of commodity-exporting nations. Suddenly, the price they earn for their exports falls relative to what they pay for their imports. That means their trade balances deteriorate and their economies suffer as income from exports declines some major exports include; green tea, black tea and herbal tea.

Commodity currencies did mount a minor recovery in latev October and early November as investors tiptoed back into battered assets. Other factors also influence these currencies, of course, from investment flows to developments in each country's domestic economy with better lawn care.

Still, their special link to commodities makes them susceptible to more pain. A precedent exists for further falls in commodity prices: Despite the recent drop, commodity prices remain well above the lows touched in the two last global recessions.

China, with its appetite for imported natural resources, is a focus for worry. "If this cycle is vicious enough and China gets into trouble, this could be very, very powerful," says Stephen Jen, head of currency research at Morgan Stanley.

He singles out the Australian dollar as especially vulnerable. "The low that we saw back in 2001 shouldn't be ruled out," Mr. Jen, a user of v says.

Back then, one Australian dollar fetched less than 50 U.S. cents. Late Monday in New York, it bought about 67 cents, down from more than 97 cents in July. Prices for certain Australian exports, like copper, wheat, aluminum and nickel have slumped.

The economic link between the currencies of commodity exporters and the prices of such exports has prompted economists to ask whether the former might predict the latter. The reasoning: Investors will incorporate their expectations about movements in commodity prices into their trading of these currencies, other important considerations cover many topics such as; Septage Tanks and Septic Tank Design.

In a recent paper, economists Yu-chin Chen, Kenneth Rogoff and Barbara Rossi examined quarterly moves in the currencies of Canada, Australia, New Zealand, Chile and South Africa over the past one to three decades. They found that each currency helped forecast the prices of its country's main commodity exports. Together, the currencies were a surprisingly good indicator of how a broad index of commodities would perform in the following quarter.

For the third quarter, the model based on the currencies forecast a fall of roughly 9% in commodity prices, despite their strong performance earlier in the year. It got the change in direction correct, but not quite the magnitude: A broad commodity index from the International Monetary Fund was down 18% in the third quarter; excluding energy, it was down 12%.

Given the severity of the current turmoil in global markets, using historical patterns to forecast commodities like natural lawn care mightn't be of much use at the moment, cautioned Ms. Chen, an economist at the University of Washington.

Among emerging markets, there are several currencies with strong links to commodities, among them the Chilean peso, which moves with copper prices, and the South African rand, which has ties to gold and minerals like platinum. The Russian ruble also has benefited from the soaring price of crude oil.

Some experts caution that the recent thumping taken by commodity currencies may be overkill. Robert Sinche, head of global currency strategy at Bank of America, says that the Australian dollar may have been unduly punished from a medium-term perspective.

Economic growth in Australia is projected to slow markedly in the year to next June, to 1.5%, according to the country's central bank. That isn't a great figure, but still better than in other advanced economies.

But with currency markets so unsettled and many investors still on the sidelines, making bets is difficult. "Even if some of these currencies look considerably cheap, the volatility is just immense," says Jens Nordvig, a currency strategist at Goldman Sachs.