The Australian dollar has an increasingly important role as a reserve currency, which could remove the smoothing impact that the currency's historically strong correlation with commodity prices has had on the results of Australian mining companies.
The strong correlation between the Australian dollar and price of commodities such as iron ore and coal – which are primarily denominated in the US dollars – smoothed the results of mining companies and was of particular benefit when the performance of both was weak, according to Fitch in a research note released on January 23.
However, Australia's strong economic performance in recent years has increased the Australian dollar's popularity as a reserve currency to such an extent that the International Monetary Fund (IMF) is considering whether to include it in the fund’s regular report on foreign exchange holdings. Relatively high interest rates compared with other developed markets also continue to attract investors, adds the rating agency.
“Lower US dollar revenues from depressed commodity prices were partially offset by the translation of Australian dollar costs to the company's US dollar-denominated profit statement at a lower rate,” said Peter Archbold, senior director for corporates at Fitch.
“This demand for the Australian dollar helped the currency remain strong in 2012 despite a drop in commodity prices,” he added. “This is likely to continue to support the currency in the near term and will add to the pressure we expect mining companies to face from a combination of cost inflation and stagnant commodity prices in 2013.”
The Aussie dollar is trading at about 30% above its historical average against the US dollar, note currency analysts.
It is unclear if this decoupling will become permanent as economic conditions in other developed markets improve, notes Fitch. But if it does continue, it will increase volatility in mining companies' reported results as factors other than commodity prices have a bigger influence on the currency.
“The impact will be greatest on companies whose operations and assets are concentrated in Australia and use the US dollar as the functional currency, such as Fortescue Metals Group,” said Archbold. “For the global mining companies like BHP Billiton and Rio Tinto, the impact will be mitigated by conservative financial and leverage profiles and by their commodity and geographic diversification.”