|Summary: The Australian dollar is down, but it’s definitely not out. The sharp fall against the US dollar was not only too quick, and too far, but it was based on the false premise that the mining boom was over. It isn’t, and natural market forces should help push it back above the $US1 mark.|
|Key take-out: Resources are the dominant driving force for the $A, while negative factors have been aggressive tax policies as well as Australia being one of the most heavily regulated economies in the world.|
|Key beneficiaries: General investors. Category: Economics and strategy.|
Australia as a nation has been indeed lucky to have recently enjoyed the benefits of a low currency.
But that is set to change, with the advantages of a low exchange rate already beginning to dissipate as the Australian dollar continues a journey back to parity and beyond. Right now it is trading above US94 cents, and I predict it will move back above the US greenback in the medium term.
Please don’t shoot the messenger. This is not news or a view on the currency that most people want to hear. But it is just as important to prepare for undesired market developments as it is to enjoy favorable trends. We can only, all of us, hope that our major resource houses took advantage of the “kangaroo gift”, as I liked to call it at the time, of the currency spending a period below US90 cents. The move down to US88.5 cents was a fundamental overshoot of classic proportions.
When we consider the currency was then 20% off the high above $US1.10, and more importantly 15% lower over just a few months from the $US1.05 area where it had spent considerable time, then we can only assume that our exporters did the right thing and fully hedged several years of forward receipts at those low overshoot levels?
Then again, maybe they didn’t. Perhaps they listened to the major bank and institution forecasts of a further collapse to US80 cents, and some went as far as to suggest US70 cents. In fact, even now, many people are still expecting the currency to fall to US80 cents next year. Recently I had the pleasure of chairing a panel of Australia’s major bank chief economists, and a bearish currency sentiment was certainly still the general sentiment.
This is important, because having an understanding of how the market may be positioned at the moment is crucial to successfully grasping an idea of the future price. It would seem, on probability, that the major exporters did not in real time recognise what an opportunity the currency being near US90 cents was. Furthermore, having missed that occasion, they are now waiting for the consensus outlook of a further decline toward US80 cents to be fulfilled. In other words, our major exporters probably missed the “kangaroo gift”, and now have a continuing “need” to buy the Australian dollar.
Why did the Australian dollar fall so quickly, and so far, in the first place? Why had it previously moved above parity for such a long time, at first in 2008, and then for most of the past three years?
As I forecast in June 2006, the rise over a few years to above parity was inevitable because of some quite simple math. We are a country of just 23 million people, sitting on top of the world’s wealthiest pile of rocks, and 2 billion people, just to our north, want those rocks!
Resources are the dominant driving force in relation to the value of the Australian dollar. As well as possessing considerable mineral wealth in the midst of perhaps the most vibrant region of economic prosperity in history, we are also a major agricultural supplier.
Then there was that rather confused hawkish period by our Reserve Bank taking official interest rates to among the highest in the world. Another potential positive going forward is the post-federal election investment surge.
Negative factors for the currency have been aggressive tax policies, as well as being one of the most heavily regulated economies in the world. All in all however, the rise of the Australian dollar in recent history has largely been a function of the effective economic management by China and other Asian nations of their own economies, for this is what has driven the demand for our minerals.
This is why “fears” of an end to the resources boom had such a profound impact on the currency this year, generating such a rapid decline from above $US parity. The startling revelation we must consider right now, however, is that this was a “false” fear!
The resources boom never ended, is ongoing, and may very well accelerate. China did indeed moderate the rate of expansion in recent years from 10% to 7.5% GDP, but contrary to the majority of media headlines this is not a crisis. In fact, China along with Asia as a whole continues to demand and import ever-greater quantities of commodity resources as their economies expand.
At 7.5%, and the signs are China’s economy has at a minimum stabilised and is in all likelihood re-accelerating, China is expanding in an absolute sense at a greater rate than a decade ago. The actual demand for shiploads of iron ore and other commodities is increasing. One could hardly call this an end to the resources boom.
It is true that we have entered a plateau period in terms of capital expenditure in the resources sector, but this and even a decline in actual capex, is a net foreign trade flow positive. Australia will be importing less mining equipment while exporting more minerals, which is a positive for the Australian dollar.
Regarding commodity prices, we have not seen the consensus forecast for another sharp collapse this year. In fact, we have seen resilient and rising prices in trend terms. This was forecast here on the basis that the previous bout of commodity price volatility greatly reduced the number of planned expansions of production. The volatility in prices actually acted to reduce the theorised impending risk of global oversupply.
The consensus view was that demand would drop, as China’s economy slowed sharply, while significant new production came on line at the same time. To some degree the exact opposite has happened. Expansion plans were delayed and many fully cancelled, while China, Japan, and the Eurozone have all surprised with better-than-consensus forecast GDP outcomes.
The overall picture is one of resources demand being well in excess of what major institutions were forecasting, while oversupply fears evaporate. The outlook then for commodity prices is a continuation of a bull run that has been in place for some time.
It can only be concluded that the sell-off of the Australian dollar this year was based on a “false fear” of an end to the resources boom, and now that error in pricing is being corrected by natural market forces in the face of the consensus view that the currency should continue to decline.
In 2006, at US76 cents, when I forecast the rise to above parity for the first time, all the major banks said it was a ridiculous prediction because everyone knew the Australian dollar could never again get back above US80 cents.
Today my fresh parity calls are being met with precisely the same derision, and oddly countered with that same reference to US80 cents.
While the major banks may be in a love affair with US80 cents, I would rather risk being the messenger to warn of the impending return of the currency to its correct fundamental value, which is, quite naturally, above parity!
Clifford Bennett is chief economist at Investor Unity. www.IU.com.au/UP