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Time to buy this commodity currency?

The Australian dollar (AUD) has spiked more than 4 percent since the beginning of the month but after snapping a six-day winning streak, it's unclear whether the gains will last.

The AUD notched a seven-month high of $0.7486 on Monday but fell 0.5 percent on Tuesday and was trading down 0.2 percent in early Wednesday trade, leaving analysts questioning the three key factors impacting the currency's medium-to-long term outlook.

Commodity conundrum

Australia is a major producer of iron ore, copper, and gold so fluctuations in those prices significantly impact the local dollar. After a grueling 2015 that saw all three commodities close the year in the red, a rally is finally underway and that in turn, is lifting the Aussie.

This week has seen iron ore prices soar nearly 20 percent in its biggest daily gain since 2009, copper climb to a four-week high, and gold hover at a 13-month peak.

However, it remains to be seen whether the recovery can continue, especially in iron ore—Australia's top export.

"We've seen a degree of irrational exuberance in the iron ore market.... I really don't see any fundamental change in the overall balance between demand and supply and for that reason, we're not going to see a continuation of this price recovery," said Gavin Wendt, founding director and senior resource analyst at Mine Life.

Barclays is also betting on lower iron ore prices ahead, which adds greater pressure on the Aussie, the bank said in a Tuesday note. It has a year-tend target of 65 U.S. cents, which represents 13 percent downside from Tuesday's close of $0.7438.

The China effect

The prospect of fresh Chinese stimulus could be the secret to uncovering greater AUD gains, according to spread-betting firm IG.

"The AUD in 2016 is facing a perfect storm scenario and is ripe for a long call," said Evan Lucas, IG's market strategist on Tuesday.

"The fact that China is now looking to stimulate over the coming months and years means the perfect storm in the AUD is going to become a thunderstorm."

China will not take its foot off the growth accelerator and spend heavily on infrastructure to ensure its 2016 gross domestic product (GDP) comes within the government's 6.5-7 percent range, he continued. The People's Bank of China is also widely expected to help Beijing via a series of cuts to benchmark interest rates and bank reserve requirements.

Chinese trade data released on Tuesday also confirmed the need for aggressive monetary and fiscal expansion, with February exports slumping 25.4 percent—the steepest decline since 2009.

Because China is Australia's largest trading partner, all this stimulus is set to further buoy the AUD, Lucas noted.

But other strategists remain more hesitant in their outlook.

"Uncertainty remains over growth rates in China, as demand for resources may slow from industries experiencing over-capacity, such as housing," notes James Humpherson, currency dealer at global broker easyMarkets.

"We believe the recent strength in the AUD is a non-sustainable overreaction in the market, which has already begun its correction," he added.

Monetary policy

IG also cites stable Australian interest rates as another variable supporting the Aussie.

The Reserve Bank of Australia (RBA) has maintained its benchmark cash rate at 2 percent, a record low, for several months now and isn't likely to change course anytime soon.

In a speech on Tuesday, RBA Deputy Governor Lowe said the bank would welcome a slightly lower exchange rate, but warned that not every central bank could enjoy that.

With the European Central Bank likely to cut rates on Thursday and the Fed likely to hold off on rate hikes next week, risk currencies, including the AUD, will benefit, Lucas added.

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