The Aussie dollar isn’t following the script at all.
A ‘risk currency’ like the Aussie should tank when the world is going to hell in a hand-basket.
Australia has the 16th largest economy in the world. Yet the Australian dollar is the 5th most traded currency globally.
A big reason why it punches above its weight on the foreign exchange markets is that traders use it as a proxy for China exposure.
But now that China’s economy is decelerating fast, why hasn’t the Aussie dollar fallen further?
Even stranger is the divergence between the Aussie dollar and commodity prices. The two are normally locked in an embrace – but are now trending in opposite directions.
Where the Aussie Dollar Could Be Heading Next
What’s happening? For the answer, this morning I spoke to our technical trading guru, Slipstream Trader Murray Dawes…
Part of Murray’s trading success is that he looks at all markets, not just stock markets. That means identifying currency trends plays a big part in his analysis.
And because currency markets often set the stage for the stock markets, I asked Murray for his take on the Aussie dollar, and where he sees it going next.
Slipstream Trader’s view of the Aussie Dollar
Click here to enlarge
I asked him to explain the relationship between the Aussie dollar and commodity prices (see chart above):
‘The Aussie dollar has had a good bounce since the start of June 2012, rallying from US$0.96 to US$1.02. I remain sceptical that the rally will continue from here. Look at the chart and you can see the AUDUSD [the Aussie dollar to US dollar] chart with the CCI (Continuous Commodity Index) laid over the top. It’s quite clear that there is a very high correlation between the movements in commodities and the Aussie dollar. The interesting thing to note over the past month is the increasing divergence between the Aussie dollar and commodity prices. i.e. the rally in the Aussie dollar has not been confirmed by a rise in the CCI.
‘My reading of this would be that most of the buying in the Aussie is probably short covering as well as money finding its way here from Europe and into our bond market. Ultimately the correlation to commodities will reassert itself, and I would expect to see the Aussie fall towards the CCI on the chart.
‘Also notice that the rally in the AUDUSD has been rejected from the 50% retracement of the sell-off from early this year. The one bullish sign is that the 10 day moving average has crossed above the 35 day moving average. That is my definition of an intermediate uptrend. Until we see that signal move back into an intermediate downtrend I will be wary of the buying pressure, but once it does turn back down I will be happy to have a target of US$0.94c on the next move down, which is the low from October last year.’
A Big Call On the Aussie Dollar Going Down
The Aussie dollar is trading at $1.004 this morning, so a fall to 94c would mean a fall of just over 6% from this level. A move of that size is huge when you’re talking about a currency.
This is just Murray’s first target of course. He’ll update his readers on what he expects to happen next.
Some analysts reckon there could be much more in store. Andy Xie, who was the chief economist for Asia Pacific for Morgan Stanley, is calling the Aussie dollar to fall by 30%. Xie is no stranger to controversy, and likes to call a spade a spade. In 2006 he became infamous for saying the following:
‘Actually, Singapore’s success came mostly from being the money laundering center for corrupt Indonesian businessmen and government officials … Indonesia has no money. So Singapore isn’t doing well.’
He may be right, but that comment cost him his job. But with regard to the Aussie dollar, Xie now sees it losing 30%, taking it to around 70 cents over the next 12 months or so.
The reasons being that commodity prices will keep sliding, and foreign investors will pull out of the country. Also, Australia’s net foreign debt is around half the GDP. That’s one of the highest levels globally. The result being that the Aussie dollar will need to be devalued.
So What’s Keeping the Aussie dollar from Falling?
For now anyway, it’s the sheer volume of overseas money heading for one of the few remaining ‘safe havens’. By this I mean Australia still has an ‘AAA’ rating.
The Aussie dollar is also one of the few still giving a positive real yield. For example, the Australian 10-year bond yield is 2.96%. The inflation rate is 1.6%.
So the real yield on a 10-year is 1.36%.
That’s hardly the most exciting return in the history of finance…but amazingly, in a world full of negative real yields, 1.36% is all it takes to be the prettiest girl at the dance these days.
This ‘opportunity’ has caught the attention of central bankers who have the job of diversifying their currency holdings. With the euro on the nose, along with most other currencies, the Aussie dollar is the new favourite.
Apparently the Russian and Czech central banks have been piling in, and now Germany is getting in on the act.
They must be very confident on the long term prospects of the Aussie dollar, because it only needs to fall by 1.36% for the capital loss to wipe-out the paltry yield on the bond.
The 10-year Aussie bond yield has fallen from 5% to 2.9% in the last year. With a continuation of this trend, and further interest rate cuts, the positive real yield probably won’t be around forever.
So I’m not sure we can count on this foreign buying support indefinitely. When it dries up, we should see the Aussie dollar come back to earth and catch up with the low commodity prices. Just as Murray predicts.
What will this mean for stock prices? If Murray is right, it could mean more pain. And he’s positioning his traders to take advantage of this kind of move.
He’s calling this his ‘Big Wednesday’. To find out more, click here…
Dr. Alex Cowie
Editor, Diggers & Drillers
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Written by Dr. Alex Cowie
Dr Alex Cowie is Money Morning‘s Chief Resources Analyst. (To have his newest investment ideas delivered straight to your inbox you can subscribe to Money Morning for free here).
He is also the editor and chief analyst for Diggers and Drillers — Australia’s premier resource stock advisory service.
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