Australia – AUD and Commodity Exports

The Australian Dollar (AUD) is considered one of the world's most dependable "commodity currencies." Its price moves in lock-step with Australia's ample supply of natural resources — from iron ore and coal to agriculture. Generally, when global demand for these commodities increases, the Aussie is likely to strengthen. And when demand declines, the currency is expected to weaken.

In either case, traders and investors understand the importance of this relationship in the context of the AUD's behaviour in the forex market. In this article, we will examine the interplay between Australia's commodity exports and its currency and explain why global trade trends are as significant as the domestic economic landscape.

The Australian Dollar in the Global Market

The AUD is one of the most widely traded currencies globally, prized for both its liquidity and commodity ties. It is often viewed as a proxy for global growth due to Australia's reliance on exports to the larger economies of China, Japan, and South Korea. The AUD has a "risk-on" perception, meaning it does well when global markets feel confident and tends to lose value when uncertainty prevails.

Iron Ore: The King of Exports

Iron ore is Australia's most significant export by a wide margin, with China as its biggest consumer.

• Rising prices of iron ore: Generally, this pushes the AUD higher as the increase in revenue for exports (iron ore) indicates demand.

• Falling demand for iron ore: Weighs on the AUD, particularly when tied to a slowing China.

So traders will typically watch Chinese industrial data and steel production data as indirect indicators of the performance of the AUD.

The Importance of Energy Products and Coal in Exports

Coal, liquefied natural gas (LNG), and other energy products also contribute to Australia's support balance. The cost of energy products can have an immediate or direct influence on the value of the Australian dollar (AUD)

• Higher prices for Coal or LNG: Increased value for AUD due to trade surplus

• Weak demand globally: Dropping export revenue and therefore depreciation pressure (e.g. less value)

As the world transitions away from fossil fuel use and supply, changes in global energy markets will continue to have an influence on the Australian economy—and the value of the AUD.

Agricultural Products and Seasonality

Agricultural products play a crucial role in generating income from exports, including products such as wheat, beef, wool, and other commodities, which provide the population with a diverse range of products that meet demand. Agriculture is not the dominant export, unlike minerals or energy.

However, it allows for some diversity in Australian exports. Seasonal events (e.g., floods, droughts, or worldwide product shortages) that affect agriculture can alter the revenues of a diverse range of products and subsequently impact sentiment for the AUD.

Exposed to China

There is no single factor in the external environment that has a more substantial influence on AUD than China. China is Australia's largest single trading partner, and the demand for resource products establishes the tone for most of the export earnings generated by Australia.

• Strong growth in China: Positive for AUD, as demand for commodities is rising

• Weakness in China: It mainly weakens AUD, even if the domestic economy is stable

Due to China's significance, the AUD is sometimes referred to as a proxy for Chinese growth in the foreign exchange market.

The Reserve Bank of Australia and Monetary Policy

While the price of commodities dominated the conversation, it is essential to note that the Reserve Bank of Australia (RBA) plays a significant role beyond this context. Decisions regarding interest rates, inflation forecasts, and general monetary policy from the Reserve Bank of Australia (RBA) have an immediate impact on the Australian dollar.

• Interest rate increases: Generally strengthen the Australian dollar as they increase investor returns.

• Interest rate reductions: Tend to weaken the Australian dollar as they decrease yield differentials.

The interaction between commodity-driven growth and RBA policy decisions can make the AUD especially sensitive to both global and domestic developments.

Global risk motivation and AUD

AUD is also commonly seen as a "risk-on" currency. When global markets are experiencing positive expansion, investors typically move funds into investment currencies with high yields, such as AUD. Alternatively, in a crisis or some other time of uncertainty, capital tends to flow out of AUD into safe-haven currencies such as USD or JPY.

As such, AUD traders need to monitor not only commodities but also global markets for risk appetite.

Trade balance and currency flows

Australia's trade balance is generated primarily from export revenue. If trade balances are substantial, the AUD may be supported; however, trade deficits tend to weaken the currency as well. Variables which drive prices and revenue often determine whether balances support or detract from the currency. Thus, when considering trends in exports, the commodity boom and bust cycles have a significant impact on the AUD.

Examples to support

• Commodity Boom Positive Outlook Drivers in 2000s: Expansion of emerging economies (particularly China) generally grew demand for Australian commodities. Partly due to this positive momentum, the AUD pushed to its highest levels on record.

• 2014 to 2015 Labour of Iron Ores dropped to extreme lows in price point: Approximately 75% drop in price point reduced demand for iron ore exports, which was amongst the causes for the increasingly weakening AUD, despite domestic measures remaining relatively stable. • Pandemic Shock (2020): The Australian Dollar depreciated initially, but quickly regained strength as Chinese demand for the country's resources returned uninterrupted.

• Energy Price Rally (2022):   Rising global LNG and coal prices supported the AUD during worldwide turmoil and uncertainty.

These are clear indicators of how closely the AUD tracks the price of Australia's major exports.

Some Practical Tips for Traders

1. Watch iron ore and thermal coal prices — these are leading indicators of the AUD.

2. Pay close attention to the economic data from China, as they are the key driver in demand for Australia's major commodity exports.

3. Pay attention to RBA policy statements to gauge progress in the Australian economy.

4. Be mindful of global sentiment — the AUD appreciates on positive sentiment and depreciates on negative sentiment (crises).

5. Use AUD/USD as a reference, but also watch AUD/JPY to pick up signals of risk sentiment potentially.

The Australian dollar is not always predictable, despite an apparent correlation with commodities. At times, global risk sentiment or central bank policy can significantly influence commodity prices. Also, numerous issues can interrupt trade flows (climatic events, geopolitical tensions) that result in unpredictable volatility. Traders must consider numerous inputs when making decisions about the AUD.

summary

Australia's dollar value is closely tied to its commodity exports, particularly iron ore, coal, and energy products. While there are supplementary factors of RBA policy or economic trends, ultimately, rapport is contingent on global demand (which supplies the signal for pricing), especially from China.

As a "risk-on" currency, the AUD tends to perform well when commodities are buoyant and confidence is high, but deteriorates during times of uncertainty or global recession.

Valuable insights, for traders and investors alike, come from understanding this connection. If you are observing commodity markets, global sentiment, and RBA policy at the time of AUD activity, you will be in a better position to predict price direction. The story of Australia's dollar is ultimately a story of resources and global trade — and those who understand that connection may be able to turn it into opportunities as a trader in the forex market.