Forex trading – trading the AUD

According to the International Monetary Fund, in 2010 Australia ranked thirteenth globally in terms of GDP, twentieth for the value of its exports, and fiftieth for the size of its population.

Yet, despite only having 0.33% of the world’s population, the Australian dollar is one of the five most frequently traded currencies in the forex market. The popularity of the AUD among forex traders is due to geology, geography and government policy.

Geology

Australia has a large range of coveted natural resources including oil, gold, uranium, diamonds, iron ore, nickel, coal and agricultural products.

Geography

Australia is the most favourably situated Western country in relation to south-east Asia. Higher populations and growing economies have resulted in an insatiable demand for resources, and Australia’s resources are the most accessible. China and India have strong impacts on Australia’s trade and economic performance, along with the value of the AUD in the forex market, with the Asian countries importing Australian commodities and Australia importing Chinese and Indian machinery and consumer goods.

Government policy

Australian government policy has resulted in a stable government and economy, and a lack of intervention in the forex market, along with a Western approach to business and regulation which has not always been typical in the Asia-Pacific region.

The Reserve Bank of Australia (RBA) is quite conservative and does not intervene frequently in the forex market. And, due to inflationary concerns, the RBA has maintained Australia’s interest rates as some of the highest in the developed world. In forex, high interest rates make the AUD a popular currency with traders who use the carry trade, generally pairing it with a low-yielding currency like the JPY.

Factors that impact the AUD

Along with the economic and political variables that impact forex rates, some elements are unique to the AUD.

Economically, Australia stands out due to its heavy reliance on commodities, with mining representing over 5% of its GDP and agriculture representing 12%. Although this reliance resulted in Australia weathering the global financial crisis better than many western economies, Australia has never developed a strong manufacturing sector – resulting in a high level of foreign debt, a large current account deficit and high interest rates.

As Australia’s economy is driven by commodities, reports on crop planting, weather, harvests, mine output and metal prices all impact the AUD, thus are valuable to forex traders trading on the AUD.

This reliance also makes the AUD vulnerable to changes in the Asian markets, particularly China and India, with export demands pushing the Australian dollar higher, only to fall when the demand wanes.

Higher commodity prices often create inflationary pressures in developed countries, resulting in the Australian economy looking healthier for forex traders when resource prices raise concerns about the sustainability of growth in Europe, North America and Japan. This also makes the AUD a popular alternative for traders wanting to go long on commodity exposure and/or Asian resource demand.

The AUD in the forex market

Most major developed currencies trend up and down together, partly due to trade links between them. The AUD, in contrast, enjoys some independence from other major currencies – its health is more closely linked to commodity prices and commodity price volatility is reflected in AUD volatility.

This means the AUD is likely to continue to trade on the basis of commodity prices, and it is unlikely to lose its importance in the forex market, even as the Chinese yuan becomes more significant.