Why yuan, Aussie dollar, copper will tango together
Long term bulls on the China story can hope for the best. But as things stand presently, they must prepare for the worst. That the Chinese economy is slowing down is no new news to the investor community. Yet the news of the first ever corporate default in China has sent jitters down all asset classes -- equities, currencies and commodities.
A solar-equipment maker Shanghai Chaori Solar Energy Science and Technology Company failed to make an annual interest payment. Although it is a relatively small company, it has raised questions on the debt-repayment capacity of many small and medium enterprises in China.
Chinese exports are slowing down sharply as data over the previous weekend showed. Exports in February fell 18.1 percent from a year earlier, following a 10.6 percent increase in January.
Imports on the other hand rose 10.1 percent, implying a trade deficit of $23 billion for the month versus a surplus of $32 billion in January. As manufacturing activity and investment slows down in China, officials in Beijing have realised that they must support the ailing economy's exports in the near term.
The People's Bank of China (PBOC) has been intervening in the currency market to drive the yuan lower against the US dollar, in an attempt to make Chinese goods more competitive. The Chinese central bank is trying to curb US dollar/yuan carry trade which drove the yuan higher against the US dollar even as other emerging market currencies were selling off. Investors engaging in a carry trade borrow or sell low-yielding currencies to fund investments in higher-yielding currencies.
China accounts for almost 40 percent of the physical demand for copper. But copper is also extensively used as a collateral for financing needs in the Chinese economy. Thus, any probability of future defaults in the Chinese bond market will be negative for copper, as recent price action has demonstrated with copper trading at a four year low.
If copper prices were to fall further, selling pressure would also be added by Chinese companies which use the metal as a collateral to cover losses.
Technically, the weekly charts of copper indicate that the metal is extremely oversold. Its relative strength index (RSI) is at 30 and the weekly candlestick has gone well below the lower Bollinger Band. Both of these indicators suggest copper prices might be bottoming out soon around the $2.8 per pound price level. A relief rally from these oversold levels would support other hard commodities such as iron ore which has taken a huge beating over the past week.
But the biggest beneficiary might be the Australian dollar which might head towards the 91-93 cents level against the US dollar. It is important to note that Australia's central bank acknowledged the fact that the Aussie dollar has weakened close to a fair value over the last six months and is no longer maintaining a dovish stance to drive its currency down.
Apart from copper prices, improving Chinese data can stem the recent fall in the Yuan along with providing yet another positive catalyst for the Australian dollar.
Thus, in the coming weeks, market participants must keep an eye on the movements in copper prices, the Yuan and the Aussie dollar. They are likely to exhibit a very strong positive co-relation in the coming weeks. A rally in one of them will make the other two appreciate as well.
(Vatsal Srivastava is a senior market analyst. The views expressed are personal. He can be contacted at firstname.lastname@example.org)
(Posted on 14-03-2014)