Is It All Downhill for Commodity Currencies?

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The recent sell-off in commodity currencies triggered by a fall in demand for resources and the rush to buy U.S. dollar, may continue, say analysts, as the need to diversify capital dwindles.

Commodity prices have been hammered by worries that China's economic recovery is slowing, along with the U.S Federal Reserve hinting at a possible cutback to its stimulus plans, which is boosting the U.S. dollar.

Richard Yetsenga, head of global markets research, ANZ said the trend of diversifying capital by buying commodity currencies is reversing and weakness in this asset class will continue.

"Either we are in an environment where people are a bit confident about the world and so they worry about the Fed tapering, or equity or credit markets have a bit of a wobble and then they [commodity currencies] suffer under concerns of global growth," Yetsenga told CNBC Asia's "Squawk Box" on Monday adding that "what this means is, you want to own the core, and that includes euro, sterling and dollar, and you want to be short the periphery."

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The Australian and New Zealand dollars, known as commodity currencies, as their economies are heavily dependent on commodity exports, have in particular been under pressure in May falling around 6 percent against the U.S. dollar from monthly highs.

The Australian and New Zealand dollars have gained around 38 percent each versus the dollar since 2009 while the Canadian dollar is up 17 percent, driven by near-zero interest rates in developed markets.

But the U.S. dollar has been staging a comeback, up nearly 5 percent this year against a basket of currencies with the dollar index hitting a near three-year peak of 84.42 last week after U.S. Fed Chief Ben Bernanke's comments on tapering quantitative easing.

Mitul Kotecha, global head of currency research, Credit Agricole said he also expects the downtrend to continue in the short term as worries about China's growth and the paring back of U.S. asset purchases weigh on the currencies.

A slowdon in China, the world's largest consumer of industrial metals, has contributed to the recent fall in key commodities prices like copper, which has shed 13 percent since touching a peak in February of $8,346 a tonne for the year. On Monday, Chinese steel futures dropped more than 2 percent to their lowest in almost nine months on soft demand from the world's biggest steel consumer.

(Read More: Outlook for China's Economy Just Keeps Getting Worse)

"In the mid-term. I think you've got an environment where you've got risk appetite looking a little bit wobbly, as you get a little bit more of a reversal of capital flows - the growth worries are perhaps strengthening," Kotecha said.

Kotecha, however, points out that a bottoming out for commodity currencies like the Aussie dollar is near, and he still expects the currency to bounce back to $1.04 by the year-end. The Australian dollar was trading around 0.96 U.S. cents on Monday.

"I think the Aussie in particular has been hit too aggressively and I think a lot of bad news is priced in the Aussie dollar," Kotecha said. "We do see a fairly good bounce back - it was 1.04 not that long ago."

— By's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu