Australian Dollar Drops Sharply on RBA rate cute

Big news in the Forex arena overnight was the move by the Reserve Bank of Australia to lower interest rates by 25 basis points. Chatter had been building ahead of the actual move by the RBA that they would indeed cut rates seeing that growth in China has been slowing. Chinese consumption of Australian raw material assets has been a boon to the land down under. With their biggest customer being impacted, it only made sense to expect a move by the RBA.

This is in keeping with the general trend that we are seeing of Central Banks either keeping bond buying programs going full bore or reducing interest rates as we saw the ECB just recently do.

I want to put up a chart that might be of interest and help us get a handle somewhat on how things are shaping up in general when it comes to the overall commodity sector.

It is a combined chart of both the Goldman Sachs Commodity Index or GSCI and the Australian Dollar. (Just a reminder here that they have effectively killed my old reliable friend, the Continuous Commodity Index or CCI and thus the reason for the switch to the GSCI).

Do you see how similar the chart patterns are? Here is the same chart with the graphs overlayed. Pretty remarkable is it not?

The reason I have noted this chart is because of the historic tendency of the Australian Dollar to act as a proxy for the commodity sector in general. With all the cross currents being introduced by Central Bank interventions, the connection between the two is not as reliable as it once was; nonetheless, it does still correlate fairly well. These past two weeks, we have seen the commodity sector moving up a tad while the Aussie moves lower in a bit of a divergence.

Here is my concern - with the RBA citing slowing growth (we keep hearing this same theme over and over do we not?), it might does us well to pay heed to the future plight of the Aussie. If it were to break down further, we could expect to see continued weakness in the commodity sector as a whole.

The currency is probing the lower end of a consolidation pattern that has been in place for the last few months near the 101 region. Previous visits to this zone have generated buying which has popped the currency back north but the bounces or rallies have been losing steam. There is a descending overhead trendline that has checked any upward progress.

I am watching this 101 zone to see if it holds as it has done in the past. If it does not, I believe we are going to see additional selling in the commodity sector. This does not necessarily mean fresh shorting but it could also be in the form of long liquidation as more money flees the sector to go and chase equities ever higher.

Last week's short squeeze in copper was able to temporarily halt the slide in the red metal. That movement tended to pull the commodity sector a bit higher as we saw crude oil and the precious metals track it higher also.

I mentioned at the time that I believe rallies in copper should be sold (again, at what level is unclear). The reason for this is if the global economy continues to contract in spite of the unprecedented expansion of liquidity by concerted Central Bank activity, then traders are going to note this and will wait for a higher entry point into which to sell. If the Aussie breaks down, it will confirm their suspicions. If not, it will confirm that a range trade in the commodity sector in general is what we can expect instead of a bear trend. In other words, Central Bank actions are preventing a recessionary relapse and thus a bearish breakdown in the commodity sector as a whole but are insufficient to generate any serious, sustainable, robust growth which would be needed to shift the overall sector into a bullish trend. "Muddling along" would become the new norm.

Again, we do not have anything conclusive yet in the Aussie but it does merit watching in the weeks ahead.