Opinion: Why commodity prices will ease back from here

By Roger J Kerr The traditional volatility and wild swings in the Kiwi dollar currency movements over the Christmas/New year holiday period due to thin and illiquid market conditions came to the fore again this year. Unfortunately for local exporters struggling with the high NZD value against the USD, the exaggerated movements were not downwards below 0.7000. A combination a marginally weaker USD, higher global commodity prices and a re-surging Australian dollar lifted the Kiwi currency from pre-Xmas levels of 0.7050 to highs of 0.7450. Yet again, the appreciation of the NZ dollar had nothing to do with anything positive from the NZ economy, the Kiwi merely following the big brother currency across the ditch, the AUD. The AUD gains against the USD from below 0.9000 to highs of 0.9300 were certainly justified with the lift in hard commodity prices and stronger trade economic data out of China. On top of those AUD positives there has since been stronger trade and employment data in Australia. The "Lucky Country" is earning itself a higher exchange rate value due to superior economic performance compared to other global economies. To the detriment of the New Zealand export sector, the markets price the Kiwi dollar alongside the Australian dollar, whether it is justified or warranted on economic performance grounds or not. However, the global markets' propensity to buy commodities and shares like-there-is-no-tomorrow over recent weeks had its confidence dented last week with the unexpected early move by the Chinese authorities to tighten their monetary policy. Chinese banks are now required to hold a higher level of deposits with their central bank which in turn slows down lending/credit growth, was seen as necessary as parts of the Chinese economy overheat. Their property construction sector, in particular, boomed last year as tax and debt incentives were introduced in late 2008 as part of the Chinese stimulus response to the GFC. The Chinese are now unwinding that monetary stimulus and it could mean a slowdown in their demand to buy commodities if the infrastructure and construction boom slows up. The Chinese (and others) now hold very high levels of inventories of hard commodities; therefore they are unlikely to be aggressive buyers at the now higher commodity prices. It all points to global commodity prices reducing over coming months, particularly if global GDP growth forecasts for 2010 are progressively pared-back form overly-optimistic predictions. A weaker AUD currency, and thus a weaker NZD, will eventuate on commodity prices coming off. Looking ahead to other factors that will drive the NZD/USD value this year, the following will again be to the forefront:- - Monetary policy and interest rates Threy could be some disappointment from the markets when they realise that the NZ economy is not expanding as fast in 2010 as they expected, therefore OCR interest rate increases get pushed back to September, rather than March/April as the moneymarkets are currently pricing. The interest rate gap between the NZD and AUD suggests the Kiwi should be substantially weaker on its own account. - USD value against the Euro The financial and economic news out of Europe is certainly not getting any better and this has pressured the Euro down against the USD over recent days. That trend can be expected to continue this year. The Kiwi has temporarily dislocated away from its close correlation to the Euro, however some catch-up to the Euro weakness is likely which will pull the Kiwi back to 0.7100 in the short-term and the mid 0.6000's in the medium term as the Euro under-performs on the global FX stage. - Capital outflows from maturing bonds  NZD1 billion per month of foreign investment has to flow into New Zealand every month over the next six months to off-set the disinvestment from uridashi and euro-kiwi bonds not been renewed. Otherwise, the NZD must weaken on the capital outflows. Why would the foreign investors roll-over NZD denominated bonds when Australian interest rates on offer are higher? - NZ commodity prices  In both USD world terms and NZD index terms, our export commodity prices are currently close to record highs. That is positive economic news, however the probability has to be that these commodity prices cannot continue to increase (and are more likely to decrease) if the global economic recovery in 2010 is slow and laboured. - Net migration flows  Local economists are basing improving house prices, and thus higher interest rates, on higher net migration inflows into New Zealand this year. They may also be disappointed as the job prospects look considerably better in Australia for potential immigrants and also for local Kiwis. The year of 2010 is shaping to be the year of recovery for the USD in international currency markets as commodity prices fail to move higher and Europe falters on many fronts. The net result for the NZD/USD exchange rate is an average for the year closer to 0.6500 than 0.7500. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com