Commodity currencies wobble on cycle fears What goes up must come down: currencies of commodity exporting nations have taken a hit along with commodity prices on concerns that the commodities "supercycle" may be over. Worries about slowing economic growth, especially in China, have sent raw material prices into decline over the past week. Gold suffered its worst two-day drop in 30 years, falling to the lowest level since January 2011, while Brent crude oil dipped below $100 for the first time in nine months. Degrees of separation Year-to-date losses, currencies and commodities Commodity currencies, which belong to countries that are big exporters of materials such as iron ore, gold, copper and oil, have wobbled in the past month. The Russian rouble has fallen nearly 3 per cent against the dollar, while the Australian dollar is down about 2 per cent and the Canadian dollar has fallen 0.5 per cent. Still, commodity currencies are not as closely tied to the fortunes of commodity prices as they used to be. The correlation between seven big commodity currencies has fallen below its pre- and post-financial crisis levels, according to analysts at Nomura, who looked at the Australian, Canadian and New Zealand dollars, the South African rand, the Mexican and Chilean pesos and the Russian rouble. That is partly due to a move away from the so-called "risk on, risk off" trading that led to high levels of correlation between asset classes in recent years. Investors are now focusing more on traditional differences such as interest rates or economic growth forecasts. "Over the last several years we've been through waves of extreme movements in commodity prices and those correlations are really breaking down - if you look at commodity currencies, broadly speaking they are much less correlated than they were a year ago," says Jens Nordvig, head of currency strategy at Nomura. It means that domestic fundamentals country by country matter much more than this uniform shock that hits everyone together. Commodity currencies are also benefiting in different ways from the Bank of Japan's plans to flood its economy with more cash as part of its bond-buying scheme. The move is expected to push Japanese government bond yields lower and lead domestic investors to seek higher income overseas. Higher yielding currencies, including some commodity currencies, have appreciated on this expected Japanese demand. Traditionally, Australian assets have been particularly attractive to Japanese investors, with the yield on the Australian dollar still the highest of any developed country at 3 per cent. Higher yielding emerging market currencies such as the Russian rouble at 8.25 per cent, the South African rand at 5 per cent and the Chilean peso at 5 per cent are also popular with income seekers. Still, the BoJ effect could prove to be temporary. "We would expect the commodity currencies to gain some near-term support from a Japanese investor reallocation, with their attractive yields, liquid bond markets and high ratings," says Ian Stannard, foreign exchange strategist at Morgan Stanley. However, once the liquidity-driven support has run its course (probably over the next couple of months), we expect the weakening fundamentals, as highlighted by the weakness in raw material prices, to weigh. Commodity currencies are also under pressure from wider changes in the global foreign exchange market. A key theory is that the US dollar will continue to strengthen this year in line with US equities, which has been an unusual correlation since the start of the financial crisis in 2008. Nomura believes further bullishness on the US currency later this year will lead commodity currency prices to moderate. Analysts at Citigroup argue that the lack of correlation between commodity currencies and commodities is more symptomatic of market confusion. On the one hand, more monetary easing from large central banks such as the Federal Reserve and the BoJ should lead to more liquidity and push commodity prices up. On the other, global growth is showing signs of slowing, which should lower commodity prices. "The violently erratic moves that we are seeing across asset markets are more due to investor uncertainty over whether the dominant asset market theme will be weak global growth or central bank balance sheet expansion," says Steven Englander, head of currency research at Citi. On balance, we think the two themes favour the US dollar.