Scott Bauer, For CME Group
- Commodity currencies typically move with prices of primary commodity products due to their country’s dependence on raw material exports for income
- The Canadian dollar, Australian dollar and New Zealand dollar have strengthened in 2021 as demand for their primary commodities has increased
Commodity prices have been surging across agriculture, energy and metals. Oil has risen 95% from its March 2020 lows, copper has rallied 91% and corn has gained 47% over the last 12 months just to name a few. These staggering gains have led to talk of a commodities supercycle. A supercycle is a sustained period of abnormally strong demand growth. This can last decades and outlast the typical economic cycle.
Commodities are global in their nature, and while they are typically priced in U.S. dollars, commodity currencies typically move with the prices of primary commodity products due to these countries’ heavy dependency on the export of raw materials for income. Consequently, as the dollar weakens, the price of commodities becomes more affordable globally. The top three currencies with the tightest correlations to commodities are the Australian dollar, the Canadian dollar and the New Zealand dollar.
Canada is the fifth largest producer of crude oil and has the third largest reserves in the world. On a daily basis the correlation between oil and the Canadian dollar may fluctuate, but over the long term it has been strong. Already one of the best-performing major currencies in 2021, Canada’s dollar looks poised to become a market favorite for the remainder of 2021 and beyond. The demand for Canada’s abundant natural resources, attractive yields and proximity to the U.S. where vaccination rollouts and infrastructure spending are seen helping Canada’s biggest export market regain its footing, are a few of the reasons for the gains in the loonie.
A combination of strong commodity prices and a weakened U.S. dollar have boosted the Australian and New Zealand dollars. Despite extremely low rates of COVID-19 mortality relative to the rest of the world, tourism has been hit hard in both countries. Their commodity sectors, however, have only seen modest impacts from COVID-19.
The Australian dollar has fared better against the dollar than other currencies because commodity prices have been on a tear in anticipation of a global economic recovery. Australia’s resource assets are closely tied to the Chinese economy, which has strengthened, and global demand should help to mitigate any rift with China to keep the Aussie dollar strong. Australia is a major producer of iron ore, copper and aluminum, all of which are in demand as manufacturing picks up after the downturn. In fact, minerals and fuels accounted for 47% of Australia’s total exports according to government trade data.
Iron ore is Australia’s single biggest export earner, worth $150 billion through the first quarter of 2021. The jump in iron ore to over $200 per metric ton has been a huge tax windfall for the Australian government, which had budgeted for prices of just $55/metric ton. The demand for iron ore is likely to exceed supply for the near future.
New Zealand Dollar
The New Zealand Dollar, known as the kiwi, is defined as a commodity currency mainly due to the country’s reliance on agricultural commodities. The kiwi is also closely correlated to the Chinese economy. Rising commodity prices and the prospects of a relatively rapid vaccine rollout in New Zealand have helped the economy. In addition, the kiwi has rallied significantly against the U.S. dollar and other currencies because the Reserve Bank of New Zealand might be among the first in the world to actually tighten their fiscal policy.
The prospect of prolonged U.S. inflation may benefit all of these currencies, as the U.S. dollar remains under pressure and the world regains its footing from the COVID-19 pandemic. Their recent rise, however, is a reminder that commodity markets produce ripple effects that affect foreign exchange. As we watch to see whether a supercycle materializes, the demand for oil (Canada), iron ore (Australia) and dairy and beef (New Zealand) will be among the barometers determining the direction of these currencies.