A falling dollar can be your friend

A lower currency means higher commodity prices – especially gold – when translated into Australian dollars.

Summary: The Australian dollar’s fall is good news for commodities investors, given the benefit of direct conversion of US dollar income for a company operating in an Australian-dollar cost environment. It is also likely that over the next six months the sell-off in commodities and the Australian dollar will be complete and international investors will make their return.

Key take-out: If the Australian dollar falls to US75c, today’s gold price of $US1200 rises on conversion to $A1593. The further the dollar falls, the higher the Australian gold price lifts.

Key beneficiaries: General investors. Category: Commodities.

Gold, believe it or not, is on track to reach an all-time high next year, perhaps hitting $2000 an ounce, with the only proviso being that the record price, if achieved, will be in Australian dollars.

A similar boost to other commodity prices is also likely thanks to the fact that most are traded in US dollars. The American dollar’s rise (and the Australian dollar’s fall) is becoming a significant factor for investors in resource stocks to consider.

The currency effect – easy to dismiss as a misleading measure of the performance of mining, oil and agricultural companies – can deliver a substantial boost to the accounts of a producer if the currency change is sustained.

Given the latest flight of capital to save havens, and the sluggish performance of the Australian economy, it seems likely that the local currency is set for a prolonged period of decline.

Reserve Bank Governor Glenn Stevens says he would be happy with an exchange rate around US75c, down another US6c from its latest level, a rate which would imply a 30% fall over the past 18 months.

Some investment banks see the dollar falling even further, perhaps into the mid-US60c range, though tipping currency moves is one of the riskiest jobs in the investment world.

All that the average investor needs to know is that when it comes to commodities, a falling currency is your friend for a number of reasons.

The first, and most obvious, is the benefit of the direct conversion of US dollar income into Australian dollars for a company operating in an Australian-dollar cost environment.

The second, and less obvious effect, is on international investors who have been on the sidelines of Australian resource equities for the past few years as prices of Australia’s major exports have been plunging.

For overseas investors there is the potential of achieving a “double whammy” from a return to the Australian market when they believe the downward leg of the commodity-price cycle has run its course and is ready to turn up, and that the Australian dollar is close to its low point.

It seems unlikely that either of those events, commodity prices or currency, has reached a turning point yet, with further falls likely.

But over the next six months it is also highly likely that the sell-off in commodities and the sell-off of the Australian dollar will be complete – and that’s when international investors will make their return, potentially having a significant effect on local share prices.

The gold example is a good starting point for looking at what’s happening because since the start of 2014 the US dollar price of the metal has bobbed around but looked at over a 12-month period it has barely moved, starting the year at $US1219 an ounce and trading today at $US1200/oz.

On conversion to Australian dollars the picture is different because on the first trading day of 2014 the exchange rate was US89.82c, which produced an Australian gold price of $A1357/oz, whereas today’s $US1200/oz at an exchange rate of US81.32c represents a local gold price of $A1475/oz.

In US dollar terms gold is down $US19/oz, whereas in Australian dollars it is up $A118/oz.

A similar calculation applies to most commodities. Copper in US dollars started the year at $US3.28 a pound and has fallen to $US2.90/lb. The Australian price is down more modestly from $A3.65/lb to $A3.56/lb.

It is not easy to measure the currency effect in equity prices but it seems likely that some gold equities have started to respond to the falling dollar.

Northern Star Resources, one of the biggest local producers which has all of its assets (and costs) in Australia, seems to be an example of the currency effect at work. Since December 1, Northern Star has risen from a low on that day of 96c to recent trades at $1.27.

Discovery news at the company’s White Feather prospect near its Kanowna Belle mine in WA might have helped lift the price though any benefit from that news seems to have been very short-lived with a December 2 price bounce quickly fading.

The gold price also did little between December 1 and now, rising by $US6/oz from $US1194/oz to $US1200/oz.

The dollar is a different story, falling from US84.5c on December 1 to its current US81.32c, down more than US3c in less than three weeks, and potentially the biggest factor in Northern Star’s 32% price rise as its received gold price has risen by $A62/oz from $A1413/oz to $A1475/oz.

Because it is difficult to separate news events, from commodity price moves, from currency value moves, the best way to treat what’s happening with the Australian dollar today is to simply see it as an invisible hand lifting the financial performance of stocks able to convert US dollar income into Australian dollars.

Over the next 12 months, if the dollar continues to fall then the currency effect could become significant.

Using gold as the “canary” in the mine (it is, after all, the right colour) the numbers become quite interesting.

At the US75c exchange rate preferred by Reserve Bank Governor Stevens today’s gold price of $US1200 rises on conversion to $A1593/oz. At US70c gold reaches $A1714, and at US65c the Australian gold price gets close to an all-time high of $A1838/oz.

To clear the $A2000/oz mark, and assuming the US gold price remains at $US1200/oz, the exchange rate needs to be around US59c.

If the Australian dollar does drop that far it will obviously be signaling deep concern by international investors in the health of the Australian economy.

But, for investors with an eye on preserving their wealth, gold (and other US dollar traded commodities) start to play a useful role – confirming the point that a falling dollar can be your friend.