Commodity currencies, such as the Canadian dollar, have made big gains in recent years, but they may have further to go says BCA Research.
In a research note, BCA says that, “Despite being near multi-decade highs, the Canadian, Australian and New Zealand dollars are trading at a discount to the levels implied by their terms of trade. There are many potential sources of upside in the commodity currencies.” Therefore, it remains a long-term bull on these commodity currencies.
First, it says that the current level of commodity prices and terms of trade will drag these currencies higher over time to simply close the undervaluation gaps. This factor suggests there is about 10% upside from today’s levels, it notes. Moreover, it expects that the terms of trade will rise further, placing additional upward pressure on the fair value of the commodity currencies.
Additionally, BCA suggests there is the potential for overshooting fair value. “Canada, Australia and New Zealand are small economies. If global investors (both private and public sector) want to increase their allocation to these relatively small and illiquid currencies, they can very easily overshoot their fundamental values,” it says.
Finally, BCA says that a resource boom will boost domestic incomes and spending, which will force the central banks in these countries to keep interest rates relatively high. “In a world where the Fed, [European Central Bank, Bank of Japan, Bank of England and Swiss National Bank] have policy rates near zero, investors will be attracted to the higher interest rates in Canada, Australia and New Zealand,” it says.