Opinion: China worries may pop latest commodities run-up, drive NZD down

By Roger J Kerr The tight link between the NZD and AUD is slowly breaking down as we anticipated, and as reflected in the NZD/AUD cross-rate falling below previous lows to new 10-year lows of 0.7600. However the AUD remains the largest single largest influence over the day-to-day NZD/USD movements. One still has to be confident of the currency outlook that the NZD/USD rate will move lower over coming months as the USD strengthens to 1.3000 against the Euro. However, as I have stated several times over recent weeks, it also requires global commodity prices to be pulling back down to bring the AUD back below 0.9000 and lower. The jury is still very much out on when and how commodity prices will behave this year after the dramatic spike higher in 2008, the big collapse and then the recovery upwards again last year. Worldwide industrial demand and supply are of course the underlying and fundamental drivers of commodity prices (including oil). However financial players in commodities markets are increasingly important as price-drivers. Much of the demand that pushed commodity prices up last year from the lows were pension fund managers who allocated greater weightings to commodities as an investment asset class as they diversified away from equities, fixed interest and property categories. Hedge funds and speculators then jumped onto that commodity buying bandwagon and possibly exaggerated the price gains in 2009 to be well ahead of the global economic demand curve. Whether the CRB commodity price index at 275 today is still above likely global GDP growth and demand in 2010/2011 is a mute point. The lack of clear direction in the CRB Index over recent months tells us that the commodity markets themselves are uncertain and confused on this point as well. The widely expected global economic recovery in 2010 has had some spanners thrown into the works via monetary policy tightening in China and European economic crises. The pension fund managers are not selling commodities to reduce or hedge price exposures yet, however if the hedge funds and speculators start to sell they could entice these other financial participants to act. Examining long-term trends in commodity prices is important after the wild gyrations of recent years. The CRB Index contains the 20 major commodity prices in the world (oil, metals and food commodity prices). The chart below suggests that the current CRB Index at 275 is still above the long-term (36 years since 1974) average of 242 and the general upward sloping trend-line. The ultimate driver of price changes this year will be more do with Chinese demand and inventory levels than what the financial players do. My view is that commodity prices will reduce, but probably not below 240 on the CRB Index. If that occurs, the AUD will be 10% lower against the USD as well. —————- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com