Bond and forex traders are treating Australia as a massive iron ore hedge fund

Place your bets! (Alan-Crowhurst/Stringer)

Even the most casual observer of Australian markets and economics knows there has been an extended discussion about the end of the mining investment boom and the crash in iron ore prices.

This is a result of all the supply that has come online over the past year or so.

So much so that the Treasurer, the RBA and others are talking loudly about the impact on Australia’s terms of trade and the resultant fall in national income. The impact of the fall in iron ore has naturally been felt in the prices of assets like the Aussie dollar and expectations about the path of RBA interest rates.

Even though iron ore is Australia’s largest export, accounting for around 22% of total exports, it still only accounts for 4% of GDP.

That’s why this chart on the correlation between the Australian Government-US Treasury spread and the price of iron ore is so startling.

It shows the impact of market sentiment on asset prices and differentials. It’s also an amazingly strong directional correlation, given the impact of iron ore on the terms of trade.

When you tie up the impact of iron ore on the Aussie-US bond spread and the AUDUSD directly as Chris Weston, IG’s Chief Market Strategist Australia, has done in a note to clients today, you get a real sense that traders are punting bonds and the Aussie dollar on the back of the big swings in iron ore.

Source: IG/Bloomberg

It’s almost impossible to argue against this theory based on the recent price movements in the markets he’s discussed.

That leaves us with one obvious result — while other factors, like the US dollar, are important, it looks like traders are treating the Aussie dollar as a giant bet on iron ore prices.

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