Australian dollar decouples from iron ore

A few months ago I investigated the growing the divergence between a weak thermal coal price and strong iron ore as well as coking coal commodity markets. The divergence continues but the relative strength has reversed. Here are the overnight prices:

The bounce from the recent lows for thermal coal is not yet convincing:

Thermal coal demand is less China centric than coking but China is still the marginal buyer. There is hope in its recent coal shipping indexes but it’s still too early to say:

Now to the weakening component. Here’s is the chart for iron ore and 12 month swaps:

The broken support I identified earlier in the week has led to an accelerating move down. Iron ore is now within a whisker of its argued fundamental support at $120 and futures are closing in on a new cycle low. I expect both to break.

And here is why, Chinese steel prices are still falling:

Both Shanghai rebar and Tangshan billet are weak with no end in sight. There’s little hope in the Chinese coastal bulk shiping index either:

Clearly, either demand for Chinese steel is off a lot or there is a glut of the stuff lying around, or both.

There is better news in coking coal which is holding just below $220, where it has been for several months. But if iron ore keeps sliding it is surely only a matter of time.

If you’d asked any economic grey-beard over the past few years why the dollar has been so strong they would have told you that the main reason was the iron ore price. Combined with coking coal, the two make up around 40% of the terms of trade and are, really, the commodities boom that underpins the dollar.

But if you look at an AUD versus iron ore spot chart, you will see that that relationship is breaking, and fast:

The brown and green lines are the 200 day moving averages. You can see the nice correlation post GFC and the more recent widening departure.

It is well documented that the strength in the dollar is now based upon a number of other factors, including mining capital inflows, as well as financial flows from reserve banks and carry traders, but to my mind, so long as iron ore falls away like this, the dollar is departing from fundamentals.

Comments

  1. Deus Forex Machina

    Yep – economic fundamentals certainly but it seems investment fundamentals are driving this thing at the moment.

    Might have to post on investment fundamentals next week.

  2. This decoupling is really interesting. I think it has to do with inflationary expectations and sovereign debt.

    If the 30 year rate is less than the inflation rate this is basically CB money printing and ultimately inflationary. Australia is one of the few countries where the 30 year rate is still above the inflation rate. So I think you have to take into account the inflation rate/money printing effect as well as the interest rate differential effect.

  3. and if you had to parse central bank actions what Bernanke is saying is:
    We want a lower USD

    What is the ultimate effect of the fed buying treasuries so that the yield is less than the expected rate of inflation over that period ?

  4. Seriously if this A$ is not one of the great shorts of all time, l will go he.
    What a mixed up world we live in if people view australian dollars as a good place to protect wealth.