The Relationship Between Commodity Prices and the Australian Dollar

Abstract

Australia is a major exporter of mining and agricultural commodities. These commodities are often invoiced in USD. The purpose of this study is to examine the strength of the relationship between the nominal Australian/United States exchange rate and indexed commodity prices using monthly data between 1986 and 2001. The next issue is whether or not these time series are cointegrated and whether or not uni-directional and/or two-way causality exists. An ordinary least squares regression model on unlagged data was expected to have low and spurious explanatory power, however this picture improves significantly when first difference data are used. It is found that cointegration does not exist in the level data set. However, it is found that the variables exhibit dual causality and negative correlation, with the significantly stronger causality running from commodity prices to AUD/USD exchange rate. This implies exogeneity in commodity prices. That knowledge should assist Australian commodity exporters in making firm-value decisions regarding the hedging of their foreign exchange and commodity price exposures. Because the level data do not exhibit cointegration, it cannot be concluded that long-term and systematic rational properties exist in the Australian exchange and commodity markets. However, when ordinary least squares regressions are applied to the first difference data, greater explanatory power of exchange rates and significant negative correlation is exhibited. Australian foreign exchange market-participants may use commodity price information to adjust their exchange rate expectations in the short-term in a sensible way.