UPDATE 1-As Australia commodities sag, A$ unable to play stimulus role

* Sliding commodity prices cloud outlook for exports, investment

* A$ defies gravity, leaving stimulus to central bank

* But mining boom not dead yet, export volumes to take up slack

By Wayne Cole

SYDNEY, July 30 (Reuters) - Sinking prices for commodities such as iron ore and coal are sapping Australia's export earnings and putting at risk billions of dollars of mining investment, a major reason it has so far dodged the recessions of the rich world.

Typically the Australian dollar would act as a safety valve, falling in line with commodities to boost exports. But this time demand from investors and central banks fleeing the euro for safer returns has seen it strengthen for the past eight weeks.

With the country's Labor government politically shackled to fiscal tightening, that puts the onus on a reluctant Reserve Bank of Australia (RBA) to provide stimulus.

The pivotal role of the Aussie dollar was underlined last week by RBA Governor Glenn Stevens when he identified two major offshore risks to Australia: a global financial crisis out of Europe and a hard landing in China. In both cases the first offset he cited was a fall in the local dollar.

"If the thing that goes wrong is a serious slump in China's economy, the Australian dollar would probably fall, which would provide expansionary impetus to the Australian economy," was Steven's assumption.

After all, this is exactly what happened back in 2008. When measured against a basket of currencies, the Australian dollar's trade weighed index (TWI) sank 30 percent in just three months giving a big boost to the country's exports.

And it seemed to be starting again earlier this year as a flare-up in the euro crisis and worries about China's slowdown saw the TWI drop 8 percent between March and May.

But not only was the decline much smaller, the pattern broke down completely in June when the currency reversed course and recouped almost all its losses.

TRIPLE-A ATTRACTION

The difference this time is a lack of alternatives. The euro faces the risk of dissolution while central banks in the U.S., UK and Switzerland are busy printing money in one form or other.

And while Australian government bond yields are at record lows they still offer an attractive premium to those in the majors -- the United States, Japan, Britain, European Union and Switzerland -- which are painfully thin or even negative.

Desperate to diversify their currency reserves, central banks from Kazakhstan to Switzerland have also been lapping up the local dollar and investing in Australian government bonds, one of the few liquid triple-A sovereign debts left.

Even the uber-conservative Bundesbank will reportedly start adding the Australian dollar to its reserves later this year.

Offshore holdings of government bonds have ballooned to over 83 percent of the A$238 billion on issue, up from 71 percent in mid-2011 and around a third a decade ago.

As a result the Aussie this month has hit lifetime highs on the euro, a more than four-year peak against the Swiss franc, a three-month top on the U.S. dollar and a four-month high on the TWI.

"The stubborn stability of the TWI, which now is near all-time highs, despite the fall in the terms of trade and downside risks to global commodity prices, is a concern," said Ben Jarman, an economist at JPMorgan.

"If it persists, this divergence represents a tightening of monetary conditions that will need to be offset through policy easing by the RBA."

The RBA cut rates in both May and June, taking them to 3.5 percent, but has recently sounded content with policy as it is.

MELTING IRON

Going by commodity prices alone, the Australian dollar should not be up here. The slowdown in China and endemic over capacity among steel makers has taken a blow torch to iron ore, the Australia's single biggest export earner.

In just the past two weeks, spot iron prices have shed 13 percent to a 9-month trough of $117.30 a tonne .

Just as worrying, the fall breached long-standing support at $130 to take prices back to depths seen in October last year, and then only briefly.

That is a huge come-down from the $164 to $184 range that held for much of 2011. Australian miners have argued that $100 to $120 will prove a floor since prices lower than this will make many higher-cost Chinese mines untenable.

However, China already has a lot of the ore stockpiled -- around 98.5 million tonnes according to consultancy Mysteel, just 3 million tonnes below February's record level.

Coal prices have also been under pressure, with Australian benchmark Newcastle coal down around 24 percent in the year to date and spot thermal coal off 18 percent.

All of which is not good news given iron ore exports alone were worth almost A$76 billion in the 12 months to May, with the various types of coal raking in A$53 billion. Combined they account for around 38 percent of the country's total exports, and about 60 percent of resource exports.

It is one reason the country has run trade deficits for the first five months of this year, ending a long string of surpluses over 2011.

Analysts fear that if sustained the lower prices will lead to project delays or even render marginal mines nonviable.

"Surveys do show the value of projects under consideration is dropping rapidly," notes Michael Blythe, chief economist at Commonwealth Bank. "There is a large pothole developing in the Australian growth profile in 2014 and beyond."

A key test will be whether BHP Billion decides to go ahead with its huge A$30 billion Olympic Dam copper and uranium expansion in South Australia. Talk is rife it will delay the go-ahead, which was due by mid-December.

BHP has already delayed a decision on a A$20 billion expansion of Port Hedland, the nation's biggest iron-ore port.

SET IN STONE

Yet the dangers can be overstated.

The long lead times in mining mean many of the projects are set in stone. The big miners remain doggedly optimistic that the urbanisation and industrialisation of billions of Chinese and Indians will drive commodity demand for decades to come and there are few signs that projects underway are in danger.

Just last week coal miner Thiess was awarded a $2.3 billion contract to extend mining operations in Queensland. Earlier in July, ConocoPhillips and Origin Energy approved a second train at its A$23 billion Australia Pacific liquefied natural gas (LNG) project.

In all, there are $170 billion-worth of LNG projects underway which have already sold years of gas going forward, mainly to power generators in Japan, China and South Korea.

That's crucial for Australia as investment is expected to account for half of all economic growth in the next few years.

Dylan Eades, an economist at Australia and New Zealand Bank estimates investment spending by all industries will top A$100 billion in 2012 and peak at A$140 billion in 2013, or one tenth of Australia's A$1.4 trillion of gross domestic product.

Spending should ease only slightly in 2014 before cooling off to around A$85 billion by 2016.

All this spending will in turn greatly boost export volumes when the projects are completed. Shipments of LNG alone are expected to triple, making Australia the world's biggest exporter ahead of Qatar.

Export volumes are expected to grow by 5 percent on average this year, and rise to more than 10 percent a year by 2015.

"To paraphrase Mark Twain, reports of the mining boom's death are greatly exaggerated," says Paul Bloxham, chief economist at HSBC.

"True, commodity prices have peaked. But there is still substantial investment yet to be completed. Plus, resource exports are yet to ramp up as a result of the added capacity that has been built."