No return in commodity, dollar split

THE relationship finally has foundered.

THE relationship finally has foundered.

For years, the Australian dollar and commodity prices have been in lockstep, constant companions as the currency faithfully shadowed the prices for the nation's major exports.

While the pair seemingly fell out of love a little over a year ago, they now barely acknowledge each other's presence and in the past few weeks they've decided to head in separate directions.

Global prices for the key steel-making ingredients iron ore and hard coking coal have been under serious pressure during the past fortnight, plunging to their lowest levels since Christmas 2009. When taken with the steady falls throughout this year, the price of iron ore, our most valuable export commodity, has dropped almost 40 per cent from last year's stratospheric peak.

During the past few weeks, however, the Australian dollar has strengthened. This is more than unusual. It is unheard of.

For the past few years, the currency driven by galloping raw materials prices has acted like a wet blanket over the economy, starving many traditional industries of oxygen.

It simultaneously pushed up the price of our exports while intensifying competition for domestic manufacturers as imports became cheaper.

Corporate earnings, for anything other than resources, have been seriously constrained as a direct result. Even those companies that expanded offshore as a natural geographic hedge, have found their earnings crimped as they converted their foreign profits into Australian dollars.

This has been a major factor in the poor performance of our stockmarket for the past three years, a market that has gone nowhere while Wall Street has pushed back towards record levels even as the American economy barely limps ahead.

With the full-year earnings season approaching, legions of local chief executives have been poised, pens in hand, to offer a glimmer of hope to jaded investors that a subdued Australian dollar would help lift earnings in the year ahead.

But it is not to be.

Despite the potential for economic disaster unfolding in Europe and China's cooling economy the kind of events that traditionally would have sent currency traders scurrying for the exits the Australian dollar simply refuses to concede ground.

When your columnist first raised the notion, almost 18 months ago, that battle scarred investors may be looking Down Under for some safety, given our low government debt, stable economic growth and high interest rates, there was a great deal of guffawing all around.

What? Us? A safe haven? The Aussie is one of the most volatile currencies in the world, they crowed. It is a speculators' delight. At least, it was.

Since then, more than 30 of the world's central banks have decided to add Australian dollar securities to their foreign reserve holdings. Even the German Bundesbank, the stalwart of Europe's faltering economic union, has decided to expand into Aussie securities.

Tomorrow night, US Federal Reserve chairman Ben Bernanke is tipped to turn up the heat on the US economy with another dose of stimulus. Traders are hoping for a further round of money printing.

There is speculation the European Central Bank will do the same later this week.

If that happens, it will have the effect of depressing both major currencies and could provide a further lift to the Australian dollar.

One of the big attractions to our dollar apart from real interest rates is its liquidity. It was always a highly traded currency because it was so volatile. Now it is in hot demand and not so volatile, because it has always attracted big volumes.

The simple fact is that money has to go somewhere, even in troubled times. When investors abandon stocks, they traditionally have headed for the safety of American treasuries, German government bonds and Japanese government debt.

But you could hardly call any of these destinations safe havens, based upon their economic fundamentals.

With so much invested in these markets at zero return, investors essentially are requesting governments to simply look after their cash.

The thinking now among traders is that they may as well park a portion of their cash in a jurisdiction that actually delivers a return. That's where the Australian dollar comes in.

That they have chosen to ignore a dramatic fall in our export commodity prices gives an indication of the fear and negativity presiding over the rest of the global economy.

To some extent, the drop in mineral prices has been mitigated by a recent surge in grain prices.

With much of the American wheat belt in the grip of severe drought, grain prices have surged in recent months and it now appears clear that Australian farmers have not planted enough to take up the slack.

In recent days there has been talk of Russia imposing export bans, as it did two years ago.

Food prices have been on the upswing for most of the past decade, driven by the same forces that have fuelled the dramatic lift in demand for minerals and energy the rapid industrialisation of Asia and China in particular.

When combined with a supply shortage such as appears likely this year, the capacity for global food shortages, as recently outlined by the United Nations, will change the dynamics for food exporting nations such as Australia.

Longer term, it is inconceivable that the Australian dollar could divorce itself from commodity prices. They are the fundamental forces that provide our income. But a reconciliation isn't on the cards any time soon.

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