Resource Currencies: Gilt By Association?

Which Index?

The linkages between currencies and commodities depend on which commodity index you use. The Goldman Sachs index (GSCI) is weighted by the economic importance of its members and as a result has a 66.69% energy weight. The GSCI's weights are very different from those of two other indices, the Commodity Research Bureau (CRB) index, which is weighted far more heavily to the grains and to tropical soft commodities such as sugar and cocoa, and the more equally balanced Dow Jones-AIG index. The CRB has the greatest weight in precious metals, and the DJ-AIG has the greatest weight in industrial commodities.

Same Commodities, Different Indices

Source: Bloomberg

On balance, none of the three commodity indices has a strong coincident or leading relationship to either the CAD or the AUD. While it's true that commodities and the two currencies have risen in 2003, both currencies managed to ignore a similar commodity price rise from mid-1999 through the end of 2000. Their simultaneous rise invites an incorrect Pavlovian response: Both countries have heavy resource sectors, so their currencies must be commodity proxies.

Commodity Indices vs. Canadian, Australian Dollars

Source: Bloomberg

The reasons behind the resurgence of the two resource currencies have little to do with gold or oil or wheat prices. The interest rate differentials between them and the U.S. dollar have grown, especially for the AUD, and this simply makes them more attractive to hold. Moreover, both central banks, like the Bank of England, have backed away from the open-spigot policy of the Greenspan Fed. Gold could be back at $260, and we would see a strong AUD given this rate gap.

Interest Rate Differentials at Six Months

Source: Bloomberg

Stocks Strong but Not Golden

If commodity prices aren't moving the currencies, are they helping these two stock markets? They certainly are not hurting either. The S&P/ASX 200 index is up 21.9% so far in 2003 in AUD terms but 32.7% in USD terms. The Canadian story is similar: The Canadian S&P/TSX Composite is up a pedestrian 15.1% in CAD terms in 2003 but a strong 38.3% in USD terms.