The Australian, Canadian and New Zealand dollars, long buoyed by high interest rates and robust economic prospects, are expected to be among the currency market's weakest performers in 2006, burdened by forecasts of softer metal and oil prices, analysts say.
John Hardy, market strategist at Saxo Bank in Copenhagen, recommends staying away from the three so-called commodity currencies, at least in 2006, as he expects this year's blistering rally in metals and oil will lose steam. The currencies often swing with commodity prices.
The shift from market darling to dud for commodity currencies, at least in the case of the Australian and New Zealand dollars, has spanned a period of successive interest rate increases that eventually choked their economies and exacerbated their external deficits, analysts say.
China's insatiable appetite for raw materials to build infrastructure for its red-hot economy has also helped spur a rally in commodities and the currencies tied to them.
Base metals thus enjoyed a banner year in 2005, led by copper, which gained about 60 to 70 percent, according to Reuters data. US crude oil futures, on the other hand, broke above a record $70 per barrel in August. But as in any market, the uptrend in commodity prices is not likely to last forever.
"I see a more muted market in base metals next year and that should be bearish on the Aussie (Australian dollar). The Canadian dollar and Kiwi (New Zealand dollar) are also expected to underperform, with factors other than commodities having an impact as well," Hardy said.
Analysts expect base metals prices to soften in 2006 as global growth decelerates and as reserve stocks accumulate.
"The market is increasingly vulnerable to the downside and we expect that prices will begin to moderate in 2006. The extent of any correction in copper prices will be watched closely," said Pierre Vaillancourt, a mining analyst at Orion Securities in Toronto.
Analysts say the Australian dollar would be the currency most affected by weaker base metal prices. Over the last five years, base metals have shown a high correlation with movements in the Australian dollar against the US dollar. Lower housing prices, a weakening employment market and a widening trade deficit are also expected to haunt the Australian dollar well into 2006.
Analysts expect the Reserve Bank of Australia to hold rates steady at 5.5 percent for some time. Westpac is forecasting some credit easing to 5.25 percent by the end of 2006, which could diminish the allure of Australian dollar-denominated assets. Energy prices next year are likely to decline from 2005's lofty levels. Deutsche Bank sees oil prices dropping sharply in the second half of 2006 to about $50 per barrel due to forecasts of mild weather and slower global growth.
Other non-commodity factors such as the currency's overvaluation and the deceleration of the US economy in 2006 could also undermine the Canadian dollar, Saxo Bank's Hardy said.