Fed move, growing optimism lifts commodity FX

NEW YORK (Reuters) - The Federal Reserve's move to crank up the money printing presses this week has soured investors on paper assets in favor of the sort that make cars run and wedding rings shine.

And in the world of foreign exchange, that means big gains for currencies from countries that produce oil, gold, copper and other commodities -- physical assets likely to hold their value if growth recovers and inflation gets out of control.

The Australian dollar advanced 5 percent against its U.S. counterpart this week, while the Canadian dollar rose 3 percent. Norway's crown surged some 7 percent, its best week since at least 2004, according to Reuters data.

That is quite a reversal from the recent trend in which these currencies struggled as fears of a worsening world recession drove commodity prices lower.

The Fed's plan to buy more than $1 trillion in government and mortgage-backed debt, along with similar programs in Britain, Japan and Switzerland, has lowered U.S. interest rates and lifted hopes for easier credit conditions and eventual economic recovery.

"The natural reaction to that and the sharp fall in the dollar was for commodities to rally" on the view that stronger world growth later this year and next would boost demand, said Matthew Strauss, an RBC Capital Markets strategist in Toronto.

Sebastien Galy, a BNP Paribas currency strategist, said it also marked a chance to buy commodities at low prices, setting investors up for a recovery and protecting them against an oversupply of dollars that in the long run may stimulate higher inflation, eroding the value of the U.S. currency.

"At the end of the day, it's a story about debasement, and financial assets in that atmosphere will trade at a discount to physical assets," he said.

For instance, he said China, which holds most of its $1.8 trillion of foreign exchange reserves in U.S. dollars, may be better served using some of that money to secure its commodity supply via commodity currencies such as the Australian dollar.

Traders have linked some of the Aussie dollar's strength to strong Chinese demand for Australian natural resources such as copper and aluminum.

"We have already seen plenty of signs of that, and such a move should favor the Australian, Canadian and New Zealand dollars," Galy said, as well as oil-producing Norway's crown and some commodity-driven emerging market currencies.

BNP expects China to be the first major economy to recover from the global slowdown later this year, which it believes will increase commodity demand and preface a U.S. recovery in 2010.

STILL VULNERABLE TO RISK

Ashraf Laidi, a senior market analyst at CMC Markets in London, said currency investors still need to discriminate among commodity currencies, though.

Rising copper prices and the Australian economy's link with China make the Aussie dollar attractive, while oil's push above $50 a barrel increases the appeal of Norway's crown, as Norway can use oil revenues to fund fiscal stimulus.

But recent rallies notwithstanding, Laidi said the jury is still out on whether world stock markets and the global economy have hit bottom.

That makes metals and oil producer Canada's dollar and most emerging market commodity-drive currencies, such as oil and sugar exporter Brazil's real, riskier bets.

"These currencies are highly vulnerable to risk appetite, and in Canada's case, highly vulnerable to another downswing in the U.S. economy," Laidi said.

Strauss agreed, saying that while the U.S. dollar has retreated sharply from the C$1.30 level tested in early March, scope for a move back to C$1.20 is also limited.

Recent data shows Canada's economy shrank by 3.4 percent in the last three months of 2008.

And if stock markets end up renewing their sharp slide, he said, current commodity prices may not seem so cheap.

"What we can deduct from recent moves is that we are getting closer to a bottom and that a very sharp fall in commodity prices looks less likely," he said. "But we may not be there yet."

Inflation, meanwhile, remains a concern, but Laidi says it is more of a 2010 and 2011 story than one for this year.

"They're printing money, yes, but it's not inflationary yet, and as long as banks are not making it available to businesses and consumers, this remains a longer-term issue."

(Editing by Jonathan Oatis)