Australia is poised to benefit from emerging markets growth due to its location, and it is in a perfect position to gain from China’s expansion. For this reason, the Australian dollar is used by exchange traded fund investors as one measure of risk in the stock market.

“The Australian dollar is considered a commodity currency, which gradually appreciates when demand for commodities is strong. However, commodity currencies are susceptible to sudden declines during periods of high market volatility, which unfortunately has been more frequent over the last few years,” Patricia Oey for Morningstar wrote in an ETF analysis.

When markets are in a “risk-off” mood, the Australian dollar loses strength because of falling commodity and stock prices. It is for this reason that the Aussie dollar is used as a proxy for risk in markets. Some say the currency is correlated to emerging market equities and can be used as a barometer for demand in that area of the globe. [ETF Spotlight: Australian Dollar]

China’s hunger for natural resources such as coal and iron ore minerals have grown from 20% of Australia’s imports, to almost 60% in 2010, reports Oey. Australia is also the number one exporter of these commodities, as well as natural gas, among others. [ETF Spotlight: FXA]

Tension between China and Australia surfaced during 2009-2010, when China was going through a huge industrial boom. Iron ore pricing and Chinese investment in Australia were at the root of the disputes, and further disagreements could result in weaker economic health for Australia.