THERE are people who have made fortunes from betting on the direction of the Australian dollar. Unfortunately I have never met them.
This is hardly reassuring for a sharemarket investor given the pivotal role currencies play in influencing individual share prices. As we have seen in recent years, the strong Australian dollar has cruelled some local industries such as steel while providing a major fillip for a range of stocks, especially importers.
If we can't predict which way the currency is heading, we must plump for a reactive approach but prepare judiciously by running various scenarios.
Investors have seen first-hand what happens when the local dollar rises. A more interesting scenario is to prepare for a weaker local currency against the greenback. An Australian dollar closer to US90? would have a major impact on where investment dollars would flow on the sharemarket.
The Australian dollar would seem to have two major influences. In the short term, the disparity between interest rates in the United States and Australia has a powerful role to play. The US Federal Reserve's decision to keep official rates at a historical low 0.25 per cent for an extended period has been a major source of support for the Australian dollar. The effect has been strengthened by the Reserve Bank of Australia setting domestic rates at a healthy 4.25 per cent.
Possibly a stronger long-term determinant of the Australian dollar is commodity prices. To
the world, Australia is a commodity-based economy and for many investors owning the Australian dollar is a means of getting exposure to the burgeoning growth in China. The Australian dollar has been highly and directly correlated with the price of copper for many years. Therefore, a decline in commodity prices should see the currency depreciate while a jump in commodity prices would see strengthening in the currency.
In summary, a reduction in local interest rates and a downturn in commodity prices would be the recipe for the Australian dollar to take a leg down from its current lofty levels. It would be foolish to predict this is about to happen, but if, by chance, it does, we could expect the following reactions on the sharemarket.
The first major beneficiaries would be companies that earn a large portion of their income in the US. A rising greenback would mean every dollar earned in the US would be worth more in Australian dollars. Companies in this category come from various industries and include Aristocrat Leisure, PaperlinX, News Corp, ResMed, Sims Metal, Brambles, James Hardie, Cochlear, CSL and QBE Insurance. Some of these stocks have enjoyed nice runs in recent weeks as the Australian dollar has rolled off its peak.
Another group of companies that would be grateful for a weaker currency are those that compete in the Australian market against imports. A strong dollar means offshore companies are more cost competitive against the locals. The culprits that fit into this basket are domestic steel producers BlueScope Steel and OneSteel. BlueScope in particular has been pushed to the brink by the strong dollar and was forced to recapitalise its balance sheet at the end of last year. It is no surprise the company's earnings are also the most sensitive among Australia's top 300 companies to a change in the currency.
In theory, resource companies that export products such as bulk commodities, copper, zinc and nickel should also benefit from a weaker Australian dollar. It allows them to be lower-cost producers of these products and more competitive against other commodity-rich nations. However, as explained, a fall in the Australian dollar occurs in tandem with weaker commodity prices. This would exclude the mining companies as beneficiaries of a softer currency.
Possibly the companies with most to lose from a weaker Australian dollar would be our importers, and to a large extent these are the smaller companies. In simple terms, these importers would lose some of their purchasing power and the cost of doing business would jump. This would be unwelcome news for the suffering retail sectors that import a large share of their goods from China but price them in US dollars.
Many players in the sector have complained about the impact a strong Australian dollar has had on discounting of goods. In reality, the strength of the currency has been a lifeline in an extremely tough environment where consumers have curtailed spending habits and the internet has challenged the traditional model of shop fronts. The retail sector can only hope that if the currency takes a tumble it will be on the back of lower domestic interest rates, which would stimulate spending by the debt-laden general public.
No discussion about the currency's impact on the sharemarket would be complete without acknowledging the happenings of 2008.
The Australian dollar dived almost 40 per cent against the greenback in just three months. This was a nasty reaction to the collapse of Lehman Bros, and investors deserted all risk assets around the globe and ploughed into US dollars. This was an unusual event that has little to do with interest rate differentials or commodity prices. If this scenario was to happen again, don't bother about buying any shares. Stick your money under the mattress.
Former fund manager Matthew Kidman is director of WAM Capital.
The US Federal Reserve's decision to keep official rates at a historical low 0.25 per cent for an extended period has been a major source of support for the Australia dollar.
Frequently Asked Questions about this Article…
What could cause a weaker Australian dollar against the US dollar?
According to the article, two main drivers could push the Australian dollar lower: a narrowing or reversal of interest rate differentials (the US Federal Reserve keeping rates very low versus higher domestic rates) and a fall in commodity prices. The piece notes the Fed’s historical 0.25% rate and the RBA’s higher domestic rates as a short-term influence, while commodity declines (copper and other bulk commodities) are cited as a stronger long-term determinant.
How would a weaker Australian dollar affect Australian companies that earn a lot of income in the US?
A weaker Aussie would generally help companies with large US revenue because each US dollar earned would convert into more Australian dollars. The article specifically lists companies in this category such as Aristocrat Leisure, PaperlinX, News Corp, ResMed, Sims Metal, Brambles, James Hardie, Cochlear, CSL and QBE Insurance as likely beneficiaries.
Which domestic companies competing with imports would benefit from a softer Australian dollar?
The article highlights domestic producers that compete against cheaper offshore suppliers would gain from a weaker currency. In particular it names BlueScope Steel and OneSteel as steel producers that would be more competitive if the Australian dollar weakened.
Do resource and mining companies automatically benefit from a weaker Australian dollar?
Not necessarily. In theory exporters of bulk commodities, copper, zinc and nickel should gain because a weaker AUD lowers their local costs. However the article warns a fall in the Australian dollar often happens alongside weaker commodity prices, which would offset gains — so mining companies may be excluded as beneficiaries in that scenario.
How would a weaker Australian dollar affect importers and retail businesses?
Importers — many of them smaller companies — would lose purchasing power as their US-dollar costs rise, increasing the cost of doing business. The article explains this would be unwelcome for retail sectors that import heavily from China and price goods in US dollars. It also notes the strong currency has recently been a lifeline for some retailers in a tough environment.
What practical steps should everyday investors take to prepare for a weaker Australian dollar?
The article recommends a reactive, scenario-based approach: don’t try to predict exact moves but plan for different currency outcomes and assess how holdings would be affected. That means identifying which portfolio stocks earn in US dollars, which compete with imports, and which are commodity-sensitive, then adjusting exposure or hedging as appropriate.
Is there a recent historical example of a sudden Australian dollar collapse investors should remember?
Yes. The article recalls 2008, when the Australian dollar plunged almost 40% against the US dollar in about three months after the collapse of Lehman Brothers. That event was an extreme flight-to-safety into US dollars and is described as unusual and not driven primarily by interest-rate differentials or commodity moves.
Who provided the commentary in the article and what is their view on forecasting currency moves?
The commentary is from former fund manager Matthew Kidman, director of WAM Capital. His view, as presented in the article, is that currency direction is hard to predict; investors should adopt a reactive strategy and run various scenarios rather than attempting precise forecasts.
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