Aussie boost from wheat prices

Forget about the correlation between copper prices and the Australian dollar. As wheat prices surge to 11 month highs and the Australian dollar hits 4-month highs vs the greenback, It’s time to remind of the correlation between Australia’s currency and prices of wheat, owing to the nation’s role as the world’s 7^th largest exporter of the crop.

The 30% price spike in wheat so far this year, emerged from draught conditions in Russia, Ukraine and Kazakhstan as well as deteriorating crop conditions in the US this month. All this has caused production shortfalls, triggering a Russian export bank lasting into year-end. Wheat from the Black Sea region accounts for nearly 20% of world exports to North Africa and the Middle East, causing demand to shift towards supplies from Australia and Argentina.

The rise in wheat also emerged from alternative demand as farmers moved away from expensive corn and barley, which was used for feeding livestock.

One major distinction from the 2007-8 rally in wheat, the current rise is primarily concentrated in crops, whereas 6 years ago, high prices were part of the supercycle in commodities. This also means that oil prices are 25% cheaper than in 2008, sparing farmers from having to lift prices to cover costs of transporting trucks and fertilizers.

Further planting concerns ahead

Looking ahead, prices could remain high following the storms in the (Kansas, Oklahoma and Texas), which have reduced moisture and caused poor crops. Other possible bullish factors include rising chances of El Niño weather phenomenon to develop in the second half of the year, thereby triggering concerns of heat and dryness in India and Australia.

Considering Australia exports 75% of its wheat production, further gains in prices could well boost Australia’s terms of trades as well as its currency. And with Australia’s cash rates likely to have bottomed, we find that familiar correlation between bottoms in wheat prices (see chart) coinciding with the lows in the Aussie. Thus, it is no surprise that out of the top 11-traded currencies, AUD is the 2nd best performing year-to-date behind the Kiwi, while wheat’s 14% rise this year, places it as the 3rd best commodity performer, behind corn (+16%) and coffee (+63%).

Last but not least, a notable piece of seasonality for AUDUSD is that April has proven to be the best month for the pair, showing a rise over the last 14 years, with the exception of April 2000, 2004 and 2013. These are key factors to consider before any premature reactions may possibly emerge in reaction to this week’s RBA announcement.