AUD USD s correlation with cheapening copper could prove catastrophic

Last week, we looked at the weakening correlation between the value of the Canadian dollar and oil prices, noting that, “It seems unlikely that this typically tight correlation has broken on a sustainable basis, so it will be interesting to see whether oil sees a notable bounce next week or whether the loonie depreciates meaningfully to “catch down” with the recent fall in black gold” (see “Has the correlation between oil and USD/CAD gone loonie?” for more). While we haven’t seen a resolution to that divergence yet, there is another currency pair/commodity correlation that may come to the fore this week.

The Australian dollar is generally closely correlated with base metals such as iron ore and copper, and while the former has managed to stabilize over the last few weeks, copper has continued to tumble. Earlier today, copper dropped below $5,000 per metric ton in London trading. Beyond representing a significant psychological level, this is also the lowest price for the metal since the Great Financial Crisis in 2009. From a fundamental perspective, much of the recent decline can be chalked up to fears about China’s economy, which has recently slowed down to “just” 7.0% growth in the official numbers, though many analysts suspect the economy is actually growing at an even slower rate.

If copper is unable to recover from its big breakdown, it would bode ill for the Australian dollar. Last night’s RBA minutes showed that the central bank is firmly on hold, though it appears that the central bank wouldn’t mind seeing continued depreciation in its currency. To wit, the minutes noted that, “it was likely that financial market volatility would increase and the US dollar could appreciate further, including against the Australian dollar” if and when the Federal Reserve raises interest rates. The minutes also stated that China’s “policy response to the recent volatility in Chinese equity markets had clouded the medium-term economic outlook” for Australia’s economy.

At this point, the key technical level to watch on AUD/USD (left axis) is .7250, which represents previous support from earlier this month and late July. Especially if the price of iron ore starts to edge lower as well, the Aussie could retest or break this key support level later this week. Meanwhile, a recovery in copper may alleviate one bearish catalyst for AUD/USD, but without any bullish fundamental news, the pair could still remain rangebound below .7400-50.

Source: City Index