The Australian Dollar Could Get Even Stronger as BHP Billiton Signal the End of Commodity Downturn

Improving commodity demand dynamics flagged by mining giant BHP Billiton plays positive for Australia's key iron ore and coal exports and implies a positive outlook for the Aussie Dollar.

The Australian Dollar retains a positive bias on global currency markets and trades at a two year best against Pound Sterling and a three month best against the US Dollar. 

The Pound to Australian Dollar trades at 1.7073 having started 2016 at 2.0227, the Aussie to US Dollar rate at 0.7630 having started the year at 0.7288.

The Australian Dollar’s continued ascent against its major trading partners will no doubt remain a source of concern for Australian policy-makers who desire a lower exchange rate in order to boost the export of Australian goods and services.

In trying to achieve a lower AUD, much focus has been placed on the actions of the Reserve Bank of Australia (RBA) of late.

Of particular importance to AUD-watchers is whether the RBA will cut interest rates below the 1.5% mark at some point in the future.

The idea is that the lowering of the rate will in turn lower inbound investor flows as the yield advantage long-enjoyed by Australia is eroded.

This should place downward pressure on AUD, and in doing so remove a major headache for the economy which needs a weaker AUD as it attempts to rebalance away from mining.

The only problem is that cuts don’t appear to be having any dampening effect on demand for AUD.

If anything, the currency is looking a lot stronger since the August cut.

Back in May, the first rate cut had the expected effect as investors closed their long Aussie positions.

At that point the market was still fearing the central bank, ready to play its game by staying away from the AUD.

“However, at the time of the second rate cut in August, the market already had plenty of time to question the central banks’ ability to actually drive their respective currency,” says Arnaud Masset, an analyst with Swissquote Bank.

Commodities: The Key to AUD Value?

This confirms that the downside risks for the Australian Dollar must lie elsewhere, and for us, the evolving Chinese growth story remains central to the Australian Dollar’s outlook.  

We reported last week that the AUD took a rare knock on news that the issuance of new credit in China had slumped while industrial production was also down.

We like to believe that the fall in AUD was linked to this unexpectedly poor data.

Indeed, Chinese demand for Australian exports remains a key determinant of Australia’s current account health:

The above shows us that two commodities in particular are key to the China-Australia trade story: Coal and Iron Ore.

The movement of prices in both stem from demand in their largest market - China. And price changes will of course impact the earnings Australia gathers from their export.

Iron ore 62% Fe spot (cfr Tianjin) rose US$58.8/t vs US$58.0/t and, “prices maintain good levels on a rise in China domestic steel demand,” note SP Angel, the London stock brokerage.

Steel rebar 25mm was higher at US$392.5/t vs a previous US$392.1/t as China steel futures rise to their highest level since April, despite economic concerns in China and a slowdown in growth rates.

“This is despite government failure to close and rationalise steel producers,” note SP Angel.

China has however pledged to cut steel production capacity by 45mt this year, which could provide clouds to the Australian Dollar outcome were it to result in a material drop in demand for Australian iron ore exports.

However, China had only met 47% of the target cuts by the mid-year and, “the news supports prospects for maintaining seaborne iron ore prices,” say SP Angel.

Infrastructure demand is reported to be driving prices with steel intensive infrastructure programs absorbing greater-than-expected tonnages for rebar and other steel products.

Chinese traders are also reported to have been building stock levels to meet anticipated new demand and to restock inventory.

Rebar stocks fell to 3.4mt in mid-July, their lowest level since December 2011 according to Reuters.

Meanwhile, thermal coal (1st year forward cif ARA) has risen to US$57.5/t as China's attempts to cut coal capacity fall behind schedule.

China has pledged to cut coal capacity by 250mt this year with just 38% of this target seen so far.

The five year target is to cut 500mt of coal and 150mt of steel capacity.

"What is unclear if further capacity cuts will impact thermal coal output, with monthly run rates already dropping 552mt on annualised basis since December. Continued falls in domestic output will likely encourage higher domestic prices and higher seaborne imports," says Ben Davis at Liberum Capital.

So far 2016 has not quite yielded the drop in Chinese raw material demand that would presumably lead to a drop in the value of AUD.

However, we would suggest those with an interest in AUD keep watching these dynamics, as a slowdown here would surely unlock a weakening in the currency.

What do BHP Billiton’s Results Tell Us?

BHP Billiton, the world's second largest miner by revenue, and a major operator in Australia, has reported its latest operation results, with further clues as to where the commodity complex is going.

BHP Billiton reported a record loss as week commodity prices took their toll, yet they remain cautiously optimistic on the future and have told investors they believe the bottom of the commodity down-cycle has been seen.

Indeed, the largest factor behind BHP Billiton's 31% decline in revenues was the impact of lower commodity prices “across all our major commodities” amounting to US$10.71m with the company citing lower US domestic gas prices, copper and iron ore in particular.

BHP Billiton confirms that Chinese growth has stabilised and is expected to match Government targets of 6.5-7 percent per annum for the rest of 2016 while growing more slowly in the medium term.

“Reform in China will proceed in a cautious but sustained manner as the authorities seek to improve the efficiency of capital allocation, reduce excess capacity in sectors such as coal and steel while boosting the role of consumer demand and maintaining support for employment,” report BHP Billiton.

So while the results were dire the outlook regarding Chinese commodity demand remains stable it would appear.

Again, reason to suggest the AUD need not yet fear a Chinese-inspired turn in trend.

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