Commodities have enjoyed unprecedented gains over the past few months, as WTI crude oil futures hit an all-time high of $111.80/bbl while gold futures on the NYMEX surged to a record of $1,033.90/oz early in the week. However, commodity prices have plunged across the board in recent days, as traders liquidate profitable positions. The moves have made a huge impact on the forex markets, as the Australian dollar and Canadian dollars have tumbled over 4 percent this week, while the New Zealand dollar has given up over 3 percent. Will these massive declines continue?
There are strong correlations to keep in mind when it comes to the commodity dollars. The New Zealand dollar has a very high correlation with the Australian dollar, and the Australian dollar shows strong links with gold prices. Meanwhile, the Canadian dollar is well known for its correlation with oil prices (though the strength of this relationship can vary). However, did you know that gold and oil are correlated with the BDI? The relationship between the Baltic Dry Index and these commodities can be seen in the chart below, courtesy of InvestmentTools.com. It is clear that BDI tends to be a leading indicator for shifts in price action for gold and oil, and over the past week, we have already seen sharp declines. The BDI measures the cost of shipping different commodities around the world and if demand to ship is strong, the price for shipping these raw materials increases. On the other hand, if demand is weakening, the price falls. The recent drop in the BDI is our first indication that commodity hungry countries like China and India are no longer immune to the slowdown in the US.
Baltic Exchange Dry Index and Crude Oil (Logarithmic) Baltic Exchange Dry Index and Gold (Logarithmic)
Australian Dollar - With ultra-tight labor market conditions and a booming export sector, the Australian dollar rocketed higher over the past year as the Reserve Bank of Australia raised rates four times by 25bps since last August to bring the cash rate target to a 13-year high of 7.25 percent. Combine that with the jump in commodity prices and broad strength in carry trades, and it’s no wonder the AUD/USD pair surged to 24 year highs near 0.9500 in February and March of this year. Indeed, inflation risks in the Australian economy remain very much to upside given persistent growth in domestic demand, which led the RBA to forecast during their March policy meeting that CPI inflation “to be a little above 4 percent in the short term.” Furthermore, the Monetary Policy Board member “viewed the standard macroeconomic considerations as continuing to suggest the need for further tightening.” However, the RBA paid heed to the developments in the global financial markets, as they had “increased funding costs for intermediaries by more than the effects of past and expected future policy changes.” If the credit crunch and instability that the global markets are currently facing become worse, the RBA may not find it prudent to tighten monetary policy any further at the risk of paralyzing Australia’s own financial markets, which could weigh on AUD/USD in coming months.
The weekly chart zooms in on the A-B-C advance from the 2001 low. We are confident that the advance is an A-B-C rally and not part of an impulse because a 5 wave decline occurred from the 1970s high (which can be viewed here). The rally through .9400 satisfied minimum expectations for wave v of C so the idea that top is in at .9496 must be respected (we had previously favored a bigger rally towards 1.00). The implications are that a multi-year top is in place for the AUDUSD.
New Zealand Dollar – As we mentioned, the New Zealand dollar and the Australian dollar show a strong correlation to each other, which makes sense given their geographical proximity, dependence upon commodity exports, and similar trends in monetary policy changes. However, the Reserve Bank of New Zealand was the far more hawkish central bank in the Asia-Pacific region, as they did not hesitate to hike the official cash rate four times in mid-2007 to a record high of 8.25 percent. While the RBNZ continues to hold their hawkish stance, they are unlikely to consider raising rates further. Indeed, RBNZ Governor Alan Bollard said on March 6 that slowing growth in the New Zealand economy will most likely not curb inflationary pressures and that “the official cash rate will need to remain at current levels for a significant time.” Nevertheless, Bollard also cited major downside risks to growth, including “a further deterioration in the world economy, tighter credit conditions, and the potential for a more severe downturn in the housing market.” As a result, as long as CPI growth does not accelerate significantly this year, the RBNZ may be quick to cut rates in 2008 if the global and New Zealand financial markets become uncomfortably unstable. This, along with the potential for sharp drops in commodity prices add to evidence pointing towards further declines in the New Zealand dollar.
The NZDUSD weekly chart shows the entire rally from the 2000 low to now. A 5 wave advance occurred from the October 2000 low (.3897) to the March 2005 high (.7463). Since then, a large expanded flat has unfolded and may be complete. The decline from .7463 to .5927 is wave A of the flat. The rally from .5927 subdivides into 3 waves and is wave B. If a wave B top is in at .8215, then wave C is underway now. Expectations are for wave C to eventually come under .5927. How long might this take? Wave A took 16 weeks and wave B 22 weeks. Wave C should be shorter or similar to wave A in time.
Canadian Dollar – Given the strong trade relations between Canada and the US, the Canadian dollar is particularly susceptible to sell-offs when the going looks rough for their neighbor to the south. Furthermore, the Bank of Canada has had far more leeway to slash interest rates in recent months, as the rapid appreciation of the Canadian dollar throughout 2007 has led import prices to plummet, alleviating broad inflation pressures. In fact, the Bank of Canada’s monetary policy statement released following the most recent rate noted that they judge “that the balance of risks around its January projection for inflation has clearly shifted to the downside,” and that “(f)urther monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to achieve the 2 percent inflation target over the medium term.” While domestic demand in Canada remains buoyant amidst resilient labor market conditions that have continued to support income growth, the fact that the country’s primary buyer of exports may be facing recession create substantial downside risks for the Canadian economy that cannot be ignored. Like the Australian dollar and New Zealand dollar, further drops in commodities like oil will only weigh on the Loonie further, and thus, signal potential for major USD/CAD gains.
One can count 7 waves down from the 2002 top at 1.6189 in the USDCAD. 7 waves is simply two simple corrections that are joined with an X wave. The result is a complex correction; in this case a double zigzag. In percentage terms, waves W and Y are nearly identical (each wave led to roughly a 28% decline). The implications are that a multi-year low is in place for the USDCAD. Near term objectives are 1.09 and 1.16 but long term bullish potential is much greater. Be sure to check the Daily Technicals every day for updates to the patterns.
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Written by Terri Belkas, Currency Analyst, and Jamie Saettele, Technical Strategist [/B]ofForex Capital Markets LLC, DailyFX.com
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