When the Aussie dollar hit an exchange rate high of US$1.10 in middle 2011, consumers and an overseas travellers cheered because of the increased buying power they gained. For the same amount, stores could import more goods cheaply, and even pass on the savings to customers. It helped ease the effects of the GFC on the consumers’ psyche.
On the other hand, companies doing a large portion of their business overseas or domestic producers exporting goods and services bore the brunt of it in less competitive pricing and lower profits once foreign earnings were converted back to Aussie dollars.
In May, the exchange rate finally fell below parity, and kept going down until it hit a bottom of about US$0.89 in early August, brought on by continued interest rate cuts by the RBA and the consensus that Chinese import demand was falling off, further indicating Chinese economic growth may be cooling off.
International investors and Forex traders see lower interest rates as less earning power for them, so they sell off the Aussie dollar since it is seen as a proxy currency for the Chinese Yuan, which is restricted in its day-to-day price fluctuation. If the Chinese economy is up, the Aussie goes up, and vice versa.
In the case of iron ore exports, the lower dollar is helping miners like Rio Tinto (ASX: RIO) BHP Billiton (ASX: BHP) and Fortescue Metals Group (ASX: FMG), as can be shown through the shipping volumes going out of WA’s Port Hedland, which handles about 20% of all global seaborne iron.
Over the past 12 months up to August, the port has seen an increase in iron ore volume by as much as 33%, hitting a record 288 million tonnes. The port’s harbourmaster, John Finch, stated that expectations of further expansion to about 320 million tonnes for the 2013/14 year.
This is all happening at the same time that Chinese steel exports are expanding, and previously for an extended period Chinese steel makers were letting their ore stock run low as they produced, yet now they have to replenish their inventories. The lower dollar makes Australian ore more attractive in price, which leads to higher volumes.
Iron ore prices fell through $100/tonne in August 2012, sending a shock wave through the iron miners, but currently sit at around $127/tonne. This also reflects higher demand, so if the miners can’t achieve the fantastic prices they were getting just two years ago, they have to make it up by selling more.
When exchange rates go up or down, there will always be a mix of winners and losers. Some companies use forward contracts or derivatives to lock in attractive prices for the short-term to smooth out the valleys and peaks that foreign exchange causes. In this case, the miners gain by achieving higher production volumes, but each tonne earns less, so they have to rein in costs to preserve profit margins.
As they are concentrating on their costs, you should, too, when reading updates. You should lean toward diversified miners that can take a hit in one commodity because they can offset it by better earnings from another.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.