World Growth Donwgrade, China Weigh on Commodities

The combination of the World Bank's forecast for a deeper contaction this year than it anticipated as recently as March, coupled with some reports that China's commodity stockpiling is set to slow has weighed on industrial metal prices and has encouraged profit-taking in the so-called commodity currencies, like Canadian and Australian dollars, South African rand and the Brazilian reai.

The World Bank now expects the world economy to contract 2.9% this year rather than 1.7% it previously expected. Separately, news reports suggest the China may import less copper and other industrial materials in the second half of the year. Shanghai inventories reportedly stand at their highest level in nearly two years, when both the Chinese and world economies were stronger.

Cash iron ore prices of shipments to China stood at 4-month highs last week and reports suggest iron ore containing ships are clogging up the ports in Australia, Brazil and China. Some reports indicate that a greater amount of shipping capacity is tied up now (18%) than at the peak a year ago (14%).

Our quantitative work shows that the Australian and Canadian dollars have a higher correlation (at the level of percentage change) with copper than they do with gold.

Over the past year AUD and gold are have an R-squared of 0.163 while AUD and copper have an R-squared of 0.523. This year to date the R-squared are 0.031 and 0.530 respectively. And for the past three months, 0.299 and 0.634. Over the past year, CAD and gold have an R-squared of 0.285 while CAD and copper have an R-squared of 0.505. This year to date the R-squared are 0.226 and 0.5612 respectively. And for the past three months, 0.432 and 0.636.

The magnitude of the decline in the commodity currencies, which also tend to be high yielders and among the favorite for Japanese retail and institutional investors, may be aiding the yen today as positions are unwound. Lower equity prices are also encouraging action. Key test for Australian dollars comes in near $0.7830-50 with a convincing break signaling losses than could potentially run toward $0.7500. The US dollar is moving above CAD1.15 and a close above here would signal a move toward CAD1.1650 at least.