Darker skies down under
It is clear that Australia’s fortunes have taken a turn for the worse over the past year.
Making the situation even more challenging in recent weeks has been the collapse in prices for Australia’s two major exports, coal and iron ore. Since mid-April, the price for iron ore has plunged by nearly 37%, while coking coal prices have dropped by nearly a quarter. A sharp decline in Chinese demand for these two key commodities is the principal explanation. To reduce inventories, the large iron ore companies have become distressed sellers, which explains why prices have plummeted in recent weeks. Putting this into context, China accounts for more than a quarter of total Australian exports; iron ore accounts for nearly 60% of Australia’s exports to China. To make matters worse, this extraordinary demand for Australian iron ore from China over the past decade is not coming back any time soon. The construction cycle is well and truly on the slide in China, as is infrastructure demand.
Against the backdrop of this price freefall for Australia’s two major commodity exports, it is perhaps surprising that the currency is not a lot lower. Certainly, it has been sliding ever so gently in recent weeks, but the damage has been relatively minor. Part of the explanation is that the price for other major commodity exports, such as gold, wheat, copper, zinc and aluminium have all held up relatively well. In addition, traders have been determinedly adding to already sizeable Aussie long positions over the course of the summer, and the RBA expects the economy to record highly respectable growth this year of more than 3%. Finally, the thirst for the Aussie from sovereign wealth funds and central banks appears not to have been sated, judging by their recent buying foray.
Apart from the alarming drop in prices for both iron ore and coal, those who fear the worst for Australia also worry about the state of the residential property market. Frankly, the housing bubble down under puts the American version to shame; Australians gorged on mortgage debt over the past decade to satisfy their hunger for exposure to the housing market. Stockland, the largest developer in Australia, remarked that conditions in the housing market are the worst for twenty years.
Right now, as we have been warning, the AUD seems poised to extend the gradual depreciation we have witnessed so far this month. At the same time, be conscious of some rather extreme forecasts suggesting the Aussie will slide down to 70c over the next year or so. Given the very fragile global economic landscape and the heightened aversion to risk being displayed by investors, making such a bold prediction is a relatively easy task, although not necessarily helpful. If sovereign wealth funds continue to invest down under because of Australia’s healthy AAA credit rating, and global central banks re-start the printing presses, then such a precipitous decline should be avoided.