The higher Australian dollar has prompted questions about the likely impact on local extensive agricultural commodity prices. Mecardo has covered this topic before. The relationship between commodity prices and the exchange rate is not a straight forward one, assuming you can predict the exchange rate which is a big assumption. It appears time to update the earlier work to see what, if anything, has changed.
The approach in this article is to look at the rolling 12 month correlation between Australian commodity prices and the Australian to US dollar exchange rate, from 1995 onwards. This shows how much of the change in the exchange rate is reflected in the change in of the commodity price for each 12 month period.
In each graph there are two pieces of information for each commodity. Firstly, there is the sign of the relationship (telling us whether it is positive or negative) and secondly, the magnitude of the relationship (ranging from a possible plus one to a possible minus one) which is telling how much of the change in a commodity price could be attributed to change in the exchange rate.
The standard assumption is the correlation is a negative one (for example the exchange rate rises and the Australian dollar nominated commodity price falls). Figure 1 shows the rolling correlation between Australian dollar cotton prices and the Australian to US dollar exchange rate. Cotton generally has a negative correlation to the exchange rate, with the correlation rate negative two thirds of the time since 1995. The correlation was positive for one third of the time, albeit more weakly than the negative correlation.
Figure 2 compares NSW port zone prices for ASW wheat and canola to the Australian to US dollar exchange rate. Correlation for these two crops is more evenly balanced, spending around 55% of the time in negative territory especially in recent years. In some years the correlation swings strongly to the positive side, and the schematic shows that wheat and canola can have quite different correlations in some seasons.
Beef (trade steer) and lamb correlations are shown in Figure 3. The split between positive and negative correlation is more evenly split, roughly half and half. A greater domestic consumption fits with a weaker correlation to the exchange rate. In recent years, since 2022, the correlation has been positive.
Finally, in Figure 4 the merino and crossbred (28 MPG) correlation is shown. Wool can run through periods of the correlation being skewed to one side. Crossbred wool is more sensitive to the exchange rate, spending 70% of the time with a negative correlation compared to merino which is more half and half.
In summary the relationship between Australian extensive agricultural commodity prices and the Australian and US dollar exchange rate varies across time and between commodities.
What does it mean?
Factors driving a commodity can outweigh the impact of exchange rates. For example a rising international cotton price in 2010-2011 outweighed the impact of a strong Australian dollar. In the current wool market lower supply meeting firm demand is driving local prices higher despite a strong exchange rate. Blanket assumptions about the likely impact of a change in the exchange rate on a commodity price are not supported by historical data. There is too much variation.
Key Points
- The relationship between the exchange rate and local commodity prices is variable, between commodities and across time
- Cotton and crossbred wool have the strongest negative correlation to the exchange rate.
Click on figure to expand
Click on figure to expand
Click on figure to expand
Click on figure to expand
Data sources: World Bank, RBA, Profarmer, MLA, AWEX, ICS, Mecardo
