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       #Post#: 13--------------------------------------------------
       Australian Dollar and Iron Ore Prices
       By: fxvictory Date: September 12, 2014, 11:37 pm
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       The Australian dollar is the worst performing currency this
       week. It has lost about 3.5% against the greenback. This is its
       worst week in a little more than a year.
       Given that the dollar bloc and yen are the weakest currencies,
       it would seem to contradict recent media reports about how the
       carry trade is back. Carry trades by definition based on rate
       differentials not currency movement. High yield currencies can
       be bought on the basis of momentum not carry. Similarly the yen
       can be sold on momentum not simply as a funding currencies.
       Note that the Aussie's slide this week wipes out a year or more
       of carry. Australia's 10-year bond yields 3.60% and the 2-year
       yields 2.65%.
       Some observers are attributing the slide in the Australian
       dollar to the decline in iron ore prices. Iron ore prices have
       fallen by 40% this year. This Great Graphic, created on
       Bloomberg, shows the Australian dollar (white line) and iron ore
       prices (yellow line). It offers little evidence to support the
       conventional wisdom. It seems like a convenient rather than
       factual explanation.
       From a methodological point of view, for high income countries,
       capital flows are more important for determining currency
       movement than trade flows. Capital markets are bigger than the
       market for tradeable goods. We note that although speculators in
       the futures market were net short euros, yen and Swiss francs,
       they were long the dollar-bloc currencies and sterling. Part of
       this week's sell-off in the Aussie (and Canadian dollar) was
       likely the exit by stale longs in the face of strong US dollar.
       Kangaroo bonds (Aussie denominated bond by foreign issuers) have
       been very popular this year.
       The Australian dollar has also emerged as a minor reserve
       currency. This status is also not a function of the price of its
       important export. It is a AAA credit with a relatively high
       yield, which offers reserve managers an attractive
       diversification vehicle.
       Measures of purchasing power parity, like the one the OECD uses,
       estimates the Australian dollar is significantly over-valued.
       The OECD estimates that the Aussie is about 27% over-valued,
       behind he Swiss franc (~33% over-valued) and the Norwegian krone
       (~30% over-valued). These models also seem to place (undue)
       place on relative prices of goods. The decline in the Australian
       dollar is a welcome development for the RBA. If the decline is
       sustained, it may reduce the likelihood of another rate cut,
       which several Australian banks reportedly anticipated in the
       first part of 2015.
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