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New Zealand’s Dollar Looks a Good Commodity Play

As China’s slowdown takes the gloss off Australia’s economy, New Zealand’s dollar looks like a good commodity play.

Could the New Zealand dollar provide an attractive alternative commodity play to the Australian dollar, as fears multiply that the Chinese economic slowdown will hit commodity markets and send the Australian currency plunging?

The Australian dollar, or aussie, has served over the past decade as the ultimate commodity currency — rising and falling in line with expectations about the price of natural resources. These have in turn been dependent largely on expectations about China, the source of much of the increase in global commodity demand. Because Australia’s economy is based largely on natural resource exports, high Chinese economic growth has tended to foster high Australian economic growth — prompting the aussie to double in value against the U.S. dollar since 2001, and to put in strong rises against other global currencies.

Now, however, China’s economic model is starting to look decidedly creaky. Official Chinese gross domestic product (GDP) growth has eased to its slowest pace in three years, and many economists think that even this more modest rate of increase is unsustainable. A long, possibly permanent slowdown in official Chinese growth from the 8 percent-plus rates of recent years could have a severe effect on the aussie.

Superficially, the New Zealand dollar, or kiwi, is caught up in the same problem. It is, like the aussie, regarded as a commodity currency because of the importance of natural resource exports.

Crucially, however, New Zealand’s export mix is poles apart from its neighbor’s: although it has benefited from a resource boom over the past decade, it is a very different boom from that which has boosted Australia’s export revenue. Australia’s is based heavily on commodities that are entirely or largely industrial, such as iron ore and coal. These have benefited greatly from China’s rather unbalanced economic growth, tilted greatly towards the construction of infrastructure. Heavy Chinese demand for such commodities means that about 27 percent of Australian goods exports are destined for the country, making China Australia’s biggest overseas client by far. By contrast, three quarters of New Zealand’s resource exports are agricultural — and about half of these are dairy. New Zealand’s export prospects are therefore dictated largely by population rises across much of the world — creating about 80 million new potential clients a year on a net basis. A significant portion of the expansion in demand for dairy comes from China, as an ever larger middle class develops western tastes; however, the growth in demand for New Zealand agricultural products remains more broad-based than demand for Australia’s hard commodities — a figure allowing New Zealand to cope with a Chinese downturn more easily. Reinforcing this point, China accounts for only 11 percent of New Zealand goods exports, leaving it much less exposed than its Antipodean neighbor. New Zealand is, therefore, less reliant both on China in and on the highly volatile global industrial cycle.

Moreover, the precise nature of the Chinese downturn may have less effect on New Zealand’s commodity mix than on Australia’s. The Chinese government has, through policy inaction, permitted the slowdown because it is trying, in the long term, to create more balanced growth in China, through closing the historical gap between high increases in investment spending and much smaller increases in personal consumption. The former absorbs industrial goods; the latter is likely to benefit those agricultural commodities from overseas that are more exotic and more attractive to the middle class than basic staples such as rice.

“We expect the Australian dollar to weaken relative to the New Zealand dollar as Australia has more exposure to the slowing industrial commodity market than New Zealand,” says Morgan Stanley in a recent currency note. “We expect industrial and agricultural commodity prices to diverge.”

However, no currency is ever a pure global commodity play, because it cannot exist in isolation from its domestic market. Leaving aside New Zealand’s resource exposure, are domestic circumstances likely to exert upward or downward pressure on the currency?

Speculation has proved unfounded that the new governor of the Reserve Bank of New Zealand, Graeme Wheeler, might use his first interest rate meeting last Thursday to take a dovish line, preparing the market for an interest rate cut. The New Zealand economy remains strong by the current standards of developed economies, with the International Monetary Fund this month predicting GDP growth of 2.2 percent for 2012. Regardless of whatever international commodity price trends might be, the country is supported by a robust housing market and reconstruction spending after the 2011 earthquake on South Island.

Australia retains one advantage: at 3.25 percent, its central bank rate is 75 basis points above New Zealand’s. This may not, however, be an advantage for much longer. Nomura expects the Reserve Bank of Australia to cut rates for the second month in a row at its November meeting, in response to “the weaker global outlook.” A continuation of rate cuts could leave Australia vulnerable to an outflow of the hot money that has piled into the aussie in the search for decent yields, which have been elusive in the U.S. and most of Europe.

There are, however, also risks in investing in the New Zealand dollar.

Judging by figures from the Organization for Economic Cooperation and Development showing purchasing power parity — the amount of goods and services that can be bought with $100 in New Zealand, compared with the U.S. — it is about 25 percent overvalued, at a closing price for the week ending October 26 of $0.821. However, this compares with a much higher 60 percent for Australia’s overvaluation against the greenback, on the same basis.

The kiwi retains, moreover, the high risk common to all commodity currencies, which arises from the high volatility of the underlying resources. When global commodity prices crashed after the 2008 credit crunch, dairy commodities were no more able to buck the trend than others —dropping by 35 percent between 2008 and 2009, according to figures from the United Nations’ Food and Agricultural Organization. Hit by the price fall of these and other resources, the kiwi sank by 40 percent from its early 2008 peak to its early 2009 trough, before rapidly making up most of the lost ground. It is currently 2.7 percent up on the year against the U.S. dollar, recovering lost ground after hitting deep troughs in November 2011 and then in May. 

The New Zealand dollar has, however, an attractive allure, as one of only a few truly liquid currencies to offer a strong exposure to agricultural commodities. It encapsulates, therefore, the hopes and fears about global food consumption for the next decade — a topic which could become almost as important to institutional investors as to ordinary consumers.

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