Thursday, 9 May 2013

Australian Dollar, China and Iron Ore - What's behind the Aussie strength?

"It is in revolutionary periods that the culmination of previous trends and the beginning of new ones appear." - C. L. R. James, Trinidadian journalist. 

While in previous conversations we have discussed the link between China, Iron Ore and the Australian Dollar, we thought a, update was warranted given the continued strength in the Australian dollar.

Recently, China's government tightened housing market restrictions on March 1 in cities with "excessively fast" price gains.

Chinese commodities demand tends to weaken as property development slows. The Australian dollar has historically tracked the country's iron-ore exports to China - source Bloomberg:
The Australian dollar declined massively during the global financial crisis as Chinese demand fell for Australian iron ore. The currency then strengthened as exports of the commodity rebounded, coinciding with China's 4 trillion yuan ($643 billion) fiscal stimulus.

Iron ore is used to make steel, an essential material for housing development. Over the past year, as China has sought to curb housing prices, the Aussie has also tracked the relative performance of property stocks as indicated by Bloomberg.

Since June 2012, the Aussie has tended to move in tandem with the relative performance of the Chinese property sector.

Below you have the comparison between the AUD and the spread between the Shanghai Property Index and the Shanghai index - source Bloomberg:
Property stocks underperformed until March in anticipation of China's implementation of capital gains tax to cool the real estate frenzy. China's announcement of a 20 percent capital gains tax on home sales  on the 1st of March was less stringent than anticipated hence the rebound that followed. The Aussie had also fallen toward par against the U.S. dollar over the same period.

But what has been interesting has been the growing gap between the RBA's monthly commodity price index and the Australian dollar. The Australian dollar has been surprisingly resilient, as indicated by Bloomberg:

"The Reserve Bank of Australia’s decision to cut its key benchmark interest rate to a record low reflects the Australian dollar’s resilience to previous reductions and weaker commodity prices. 
The CHART OF THE DAY shows the RBA’s monthly commodity price index diverging from the local dollar by the most since the beginning of the nation’s China-fueled resource boom a decade ago. It also tracks the overnight cash-rate target that Governor Glenn Stevens and his board reduced to 2.75 percent yesterday, the lowest level since records began in June 1959. The exchange rate “has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates,” Stevens said in his 6th of May statement.
Stevens has reduced the cash rate by 2 percentage points in the past 19 months, a period when the currency has averaged more than $1.03, compared with 72 U.S. cents in the decade prior. The Aussie was at $1.0197 at 6 p.m. in Sydney yesterday. “It’s a balance between the interest rates being at record lows and the currency being high,” said Greg Gibbs, a Singapore-based senior currency strategist at Royal Bank of Scotland Group Plc. “While the currency remains unresponsive to commodity prices or interest-rate differentials, it increases the potential for rates to go lower.” Commodity prices have tumbled 21 percent from a peak in September 2011, the RBA’s gauge shows. The index “is intended to provide a timely indicator of the prices received by Australian commodity exporters,” according to the central bank’s website." - source Bloomberg

Could the reason behind the continuous resiliency in the Australian dollar due to a rebound in Iron Ore prices?

China imported 67.1 million tonnes of the steelmaking raw material in April, the third highest amount on record and up 4% from March it seems.

And, on Wednesday benchmark CFR import price of 62% iron ore fines at China's Tianjin climbed to $130.20 a tonne, up from its 2013 low of $128.10 reached last week according to Frik Els from

As far as inventories are concerned and as reported by Deutsche Bank in their latest Shipping Weekly from the 6th of May 2013, while inventories improved of their 1st quarter low, they remain below 2010 levels:
- source Deutsche Bank - Shipping Weekly - 6th of May 2013.

We do not think the resiliency of the Australian dollar is due to this rebound, there is, we think more to it and it has to do with two factors.

Factor 1 - Diversification of Central Banks FX Reserves:
The rebalancing of FX reserves as indicated by John Detrixhe in his Bloomberg article from the 3rd of April - Aussie to Loonie Equal Dollar in Attracting Reserves:
"For the first time, central banks are using their reserves to buy about the same amount of currencies from Canada to Australia as they are U.S. dollars in a sign that the pace of diversification is accelerating. Allocations to so-called non-reserve assets rose by $30.1 billion in the last three months of 2012, the most in a year, while those going to the dollar increased by $31.5 billion, according to International Monetary Fund data released on March 29. The $1.4 billion gap is the closest since at least 1999.
The changing makeup of reserve assets reflects the growing clout of second-tier nations as the major developed economies see a shrinking share of worldwide gross domestic product. The U.S., euro region, U.K. and Japan accounted for 52 percent of global GDP product in 2011, down from 69 percent a decade earlier, according to World Bank data. “The new money really got applied to the alternatives, Aussie and Canada, and it’s an ongoing trend,” Greg Anderson, the North America head of Group of 10 currency strategy at New York-based Citigroup Inc., said in a telephone interview. Those currencies have “better credit, higher yield. If you could, you’d probably put your whole portfolio there but they have a scale problem, you can’t do that,” he said.

A category the IMF calls “other currencies,” and which strategists say includes the Australian, New Zealand and Canadian dollars, soared to 6.1 percent of the $6.1 trillion in allocated global reserve assets from 1.8 percent at the end of 2007. The IMF calculates the share based on central-bank data. China, the world’s biggest reserve holder, doesn’t participate.
At the same time, the dollar percentage has shrunk to 61.9 percent from 64.1 percent, and the euro’s share has dwindled to 23.9 percent from 26.3 percent. The IMF said in November that it’s considering classifying the Australia and Canadian dollars as reserve currencies." - source Bloomberg

Factor 2 - Yuan-Aussie Trades:
As indicated in Jason Scott's Bloomberg article from the 11th of April, the Australian dollar cross-currency trading has been given a very big boost by the direct trading between the yuan and the Aussie which reached A$250 million on its first day   - Yuan-Aussie Trades Were A$250 Million on First Day:
"The People’s Bank of China approved Australia & New Zealand Banking Group Ltd. and Westpac Banking Corp. as market makers for the direct trading of the currencies that began yesterday, Gillard said at a press conference in Shanghai on April 8. Asia’s largest economy took about a third of Australia’s exports in February and is its major customer for iron ore and coal. The yuan gained 0.2 percent to 6.5167 per Australian dollar as of 2:32 p.m. in Beijing, according to data compiled by Bloomberg. The Australian dollar follows the greenback and the yen in being able to be directly traded with the yuan. Before the bilateral deal, cross-currency trading between the Aussie and the yuan was about A$20 million a day, according to data compiled by market participants, who asked not to be named." - source Bloomberg.

As far as the Yuan is concerned, you should watch what happens with the Yuan's trading range in the coming months because of the competitive devaluation taking place in Japan  - source Bloomberg:

"China won’t widen the yuan’s trading range for at least four months, as foreign inflows have pushed the currency near the upper end of the 1 percent daily limit, according to Australia & New Zealand Banking Group Ltd. “It would require an easing of capital inflows, or for the market to re-assess People’s Bank of China’s currency management” before the band is altered again, said Khoon Goh, a senior strategist at ANZ in Singapore. The central bank expanded the range from 0.5 percent in April 2012 after a stretch of at least 15 months during which the yuan hovered near the midpoint or tended to weaken. A change now would be an “effective revaluation” as other nations devalue their currencies, he said.
The CHART OF THE DAY shows the onshore yuan gained 3.4 percent against the dollar in the past nine months and has closed stronger than the reference rate since September. The lower panel shows the currency stayed near the maximum 1 percent above the fixing for the last seven months.
Speculation for a change was heightened on April 18 when PBOC Deputy Governor Yi Gang said the band would be widened “in the near future.” Based on the previous adjustment, the central bank probably won’t move “until the yuan is trading closer to the midpoint,” ANZ’s Goh said.
Yuan positions at Chinese financial institutions stemming from foreign-exchange transactions, a gauge of cross-border flows, rose by 1.22 trillion yuan ($197 billion) in the first three months of 2013, more than four times as much as in the same period last year. The inflows helped push the yuan to a 19- year high of 6.1723 per dollar on April 17." - source Bloomberg.

On Thursday the Yuan hit a record high of 6.1336 per dollar in morning Asian trade after the People's Bank of China (PBOC) fixed the yuan mid-point at the highest level since the 2005 revaluation.

What will be interesting to watch in relation to China and as reported by EJ Insight on the 8th of May is as follows:

"New forex position limits could tighten cash flow Starting June 10, banks in China are required to comply with new foreign exchange position limits. The State Administration of Foreign Exchange, the nation’s currency regulator, has linked the position limits to the banks’ foreign currency loan-deposit ratios.
Market analysts estimate the lenders need to buy as much as US$320 billion worth of US dollar to meet the new ratio. This could lead to tighter cash flow in the financial system and higher money rates for a short period. As a result, the central bank may keep a net cash injection via its open market operations.
On the other hand, the new measure, which is aimed at containing the influx of speculative capital, is timely and important at a time when other major economies are exercising monetary easing.
After Australia cut interest rates on Tuesday, South Korea’s central bank is likely to announce a long awaited cut today. According to official data, yuan positions at Chinese financial institutions from foreign exchange transactions rose by 1.22 trillion yuan (US$197 billion) in the first quarter."

And Korea did cut its interest rates by 25 bps. The race to the bottom is on and currency wars are indeed interesting to follow.

"The thing is to be able to outlast the trends." - Paul Anka, Canadian musician.

Stay tuned!

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