Copper Price Dynamics and the Australian Dollar Valuation Question

Why the Australian dollar should be considered overvalued and why the future of copper prices matter.

Australia produces almost a million metric tons of copper annually, and contains the world’s sixth largest resource of economically viable copper reserves.

It is also the country’s 9th largest export and a useful economic barometer as it is a handy guide on direction in the Australian dollar’s valuation.

In fact, the religious zeal with which the AUD/USD follows the copper price allows us to figure out when the Australian dollar is either over- or under-valued.

As the below shows, the Aussie will always revert back to the copper price until such a time that the Australian economy is able to fully detach itself from its reliance on the mining sector. That time is not now, and while the economy is shifting away from this reliance there is some distance yet to travel.  

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Interestingly, the above tells us that the Australian dollar is fundamentally overvalued at this stage in time, having potentially over-extended itself during the course of the 2016 commodity sector recovery.

Either the copper price needs to come up or the Australian dollar comes down.

According to the most recent analysis of copper market fundamentals conducted by analysts at Barclays, the copper price is not likely to rise.

“Over the past week, copper prices have converged with our view that the recent rally was unsustainable, as it was built on transient technical factors and poor fundamentals,” says Dane Davis, a commodity analyst with Barclays.

An oversupply of copper is considered one of the main drivers of the decline:

“In inventory data, China’s total coper inventories have climbed to an estimated 938kt, the highest combined total since April 2014,” says Davis.

The slow-down in the Chinese economy is a further reason for expecting copper to fall:

“In the second quarter, we see copper continuing to weaken, as the seasonal uptick in Chinese economic activity is not enough to offset strong inventory levels and a worrisome medium-term outlook.”

Consider further the fact that as reported by Bloomberg News, Shanghai’s biggest futures brokers have switched to a net-short position on copper, from a previous net long position.

Net short positioning, as of 1 April, rose to 12,058 contracts on SHFE, from the previous week’s 1,063 contracts net long position.

Barclays forecast that copper prices will continue falling, averaging 4520 dollars (per ton) in Q2, before falling even lower to 4180 in the 4th quarter.

A Lower Aussie Dollar

So if copper is unlikely to rise then for the tight correlation between copper and AUD to continue, as it has done for many years now, the Aussie dollar must presumably come down.

Maybe this is something Reserve Bank of Australia (RBA) Governor Stevens and his team know.

While the RBA suggested on Tuesday the 5th of April that the Australian dollar was becoming uncomfortably strong, there was also a willingness to allow market forces to deal with the currency.

Maybe Stevens & Co. are watching the currency’s relationship with copper?