Safe as an Aussie dollar?

The Australian dollar remained slightly above parity overnight, continuing to defy those who are betting that the sharp slide in commodity prices will cause the currency to tumble.

A number of hedge funds have been shorting the Australian dollar, believing that, with commodity prices dropping sharply, it's only a matter of time before the currency follows suit.

Copper – which has such a good track record in predicting global growth trends that it is frequently dubbed ‘Dr Copper', the commodity with a PhD in economics – has now fallen around 15 per cent from its February peak. Energy prices tell a similarly gloomy story, with the price of crude falling by around 25 per cent in the past three months, while thermal coal is down 18 per cent. At the same time charter rates for oil tankers, an indicator of the level of global demand for crude oil, have slumped by 75 per cent since early April.

Last week, the US central bank disappointed markets by deciding not to launch a major new bond buying program – QE3 – even though it recognised that US growth was faltering. And the market has already given up hope that this week's summit of European leaders will produce any new initiative that will solve the region's dire debt problems and prevent it from sliding deeper into recession.

But other analysts argue that there are reasons for the Australian dollar's resilience. They point out that all the 'commodity currencies' – which belong to industrialised countries such as Australia, Canada, New Zealand and Norway which also happen to be big commodity exporters – have held up remarkably well. Indeed in the past three months, the 'commodity currencies' have only fallen by around 3 to 4 per cent against the greenback, despite the sharp slide in commodity prices.

One reason for this is that these countries offer higher interest rates, which are hugely attractive for global investors hunting for yield. Even though the Reserve Bank is cutting interest rates, Australia's official interest rate of 3.5 per cent remains the highest nominal rate of any industrialised country, which is supporting the local currency.

What's more, the 'commodity currencies' belong to the shrinking group of developed countries that have been able to hold onto their prized triple-A credit ratings. This makes Australian bonds hugely attractive to conservative investors, including foreign pension funds, many of which have a mandate that requires them to buy only triple-A rated securities, and which see Australian securities a 'safe haven'.

And it's not only private investors that are attracted to buying the 'commodity currency' bonds. Central banks, wary of incurring losses on their holdings of US dollars and euros, are increasingly looking to diversify their investments. Russia's central bank has recently indicated that it could allocate up to 1 per cent of its foreign exchange reserves in Australian dollar assets, which could see it buying up to $5.1 billion in Australian bonds.

In addition, the Australian dollar is also being buoyed by the perception that China – which is an important buyer of our commodities – is taking steps to stimulate its economy. Beijing has already introduced a range of measures to boost growth, including cutting interest rates, reducing the level of reserves that the banks are forced to hold, and offering consumers incentives to encourage them to buy domestic appliances.

But despite Beijing's stimulus, many hedge funds remain confident that the local currency will eventually stumble. The Australian dollar, they argue, will simply not be able to withstand the mighty headwinds coming from a sharp slowdown in US and European growth, which will cause commodity prices to plummet even further.

And they point to history as a guide. When commodity prices were sent reeling between July 2008 and February 2009, the worst performing currencies were, in order, the Polish zloty, the Hungarian forint, the Czech koruna and the Russian ruble, followed by the Australian dollar.