Recent news from Australia may provide more evidence that what happens in Beijing is being felt across the globe. In this case, I believe that slowing demand for commodities in China could have a profound effect on the Australian dollar.
Recently, BHP Billiton, the world’s largest mining company, announced its decision to delay two major investment projects in its native Australia, worth around $50 billion. The first project was the expansion of the Olympic Dam mine in Southern Australia, which would have been the biggest open pit mine in the world, extracting copper, gold, silver and uranium. The second project was the expansion of the harbor in Port Hedland, Australia’s biggest port by tonnage, and its main shipping port for iron ore, Australia’s largest commodity export. That these major projects are now off the table begs the question: Are mining companies re-assessing the profitability of investment projects in reaction to the ongoing decline in some key commodity prices?
If so, there’s reason to be concerned about the health of the Australian dollar, which up to this point has proved remarkably resilient despite a meaningful deterioration in its fundamentals. The prices of Australia’s two biggest commodity exports, iron ore and coal, have fallen by 31% and 17% year to date, respectively. Moreover, I believe the ongoing decline in Chinese steel prices, down 20% year to date, points to additional weakness in the iron ore market in the near future. In fact, growth rates in Chinese steel production and iron ore imports have flattened out for nearly two years. If the tight relationship between steel and iron ore prices remains in place, Australia is on track to see its terms of trade (defined as the ratio between export and import prices) decline by 15% for 2012.
What concerns me is that mining is such a large part of the Australian economy. Over the past two years, the resilience of the mining sector has supported the Australian economy as other sectors suffered from deleveraging, slowing consumption and flat to negative job creation. More specifically, the mining sector’s direct contribution has averaged about 20% of Australian growth over the past year, and 15% over the past five years. This climbs to 50% if you include the indirect impact coming from the construction, transport and professional services industries linked to the mining sector. Additionally, the mining industry represents about 55% of all Australian exports and was responsible for adding about 77% of all new jobs in the first and second quarters of this year. This last fact is remarkable considering that only 2% of the labor force works in the mining sector1.
So what does this all mean for the Australian dollar? To my mind, the main reason behind the Australian dollar’s resiliency is that Australia is the highest yielding AAA-rated country in the world, therefore benefiting from the ever shrinking amount of AAA paper available as a result of ongoing credit downgrades in the developed world. But this type of flow only has a temporary impact and I believe eventually Australia’s currency will catch up with its broader set of deteriorating fundamentals.
While the headwinds in commodity markets and mining investments could open up opportunities for other areas in Australia, such as domestic manufacturing and service sectors, I believe the Australian dollar is particularly vulnerable. For this reason, we have no Aussie dollar exposure in our currency fund and we look for tactical opportunities to place some small net short positions.
- Australian Bureau of Statistics, 6/30/12.
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