The top news at the start of the week is the ongoing meltdown in the metals market. Gold prices have dropped more than $1,200 per ounce in less than a week. The collapse in silver prices has been even more dramatic. Copper and iron ore prices are also retreating. All of this is particularly relevant to the Aussie dollar, which has managed to hold up ahead of an expected rate hike by the RBA on Tuesday.

A market move of this magnitude will likely have multiple factors behind it. Some traders are increasingly worried that the sell-off in gold is a sign that they are raising cash to shore up other assets, as tech stocks have also underperformed. This could mean further downside for global equities in the coming weeks. Even if that were not the case, analysts point to the increasing influence of Chinese speculators in the metals market. Given Australia’s reliance on exports to China, this could have additional implications for the AUD.
 

Record Drops, Record Cash Flows

Silver’s 26% price drop on Friday is the biggest on record, while gold suffered the worst performance in nearly four decades. The move in copper – and Australia is the world’s fifth largest producer – was just as dramatic. Australia’s main export, iron ore, trended lower from multi-year highs, but still holds above $100/ton.

The moves were so big that the Chicago Metals Exchange (CME) doubled its reserve requirements to trade in precious metals. The requirement for more capital to access the market will put a significant obstacle to markets in the short term. Nevertheless, analysts and brokers are still optimistic about precious metals in the long term. JPMorgan, for example, raised its price target to $6,300 by the end of the year, suggesting that fundamentals remain in place for further upside. Many analysts say that January’s rush higher in gold was driven by speculation overtaking fundamentals, meaning the moves over the last couple of days were a correction, not a change in direction.
 

China, Australia, and Metals Demand

The rally in metals during January was attributed to massive inflows in to ETF, with the funds originating in China. The Asian trading day had some of the largest moves in metals prices. China’s central bank has moved to ease currency restrictions as the country struggles to reassess its value storage system in the wake of the collapse of the housing market. Individual traders have turned to metals as a store of value, pushing the price higher.

The profit-taking that turned markets over on Thursday has been attributed to Chinese investors, as metals started the day limit down on Monday. While the trading markets remain frothy, export contracts that drive the AUD remain in place. Now the focus turns to the RBA, which is widely expected to raise rates, but could open substantial weakness in the currency if it fails to deliver.
 

RBA Unaffected by the Crash

Despite the sudden drop in the price of Australia’s exports, economists remain unanimous in expecting the RBA to raise rates by 25 bps on Tuesday. The Australian economy has remained hot during the antipodean summer, and Q4 inflation was above the central bank’s expectations.

The focus then turns to RBA Governor Bullock’s commentary to see if the bank will play it by ear, hiking now and waiting to see the effects until next quarter. Or, it will take a more aggressive policy, signalling the possibility of another rate hike at the next meeting. Both could be bullish for the AUD, as investors keep an eye on developments in China.

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