Sharp fall in $A would rock the boat

There are people who have made fortunes from betting on the future direction of the Australian dollar. Unfortunately, I have never met them.

There are people who have made fortunes from betting on the future direction of the Australian dollar. Unfortunately, I have never met them.

This is hardly reassuring for a stockmarket investor given the pivotal role currencies play 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 opt 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 US dollar. An Australian dollar closer to US90? would have a major impact on where investment dollars would flow on the stockmarket.

The Australian dollar would seem to have two major influences. In the short term, the disparity between interest rates in the US and Australia has a powerful role to play. The US Federal Reserve's decision to keep official rates at an historical low of 0.25 per cent for an extended period has been a major source of support for the Australia dollar. This has been exacerbated 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 are commodity prices. To the world Australia is a commodity-based economy and for many investors owning the Aussie 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 stock market.

The first major beneficiaries would be those 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 Inc, 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 of a weaker currency are those which 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 the domestic steel producers BlueScope Steel and OneSteel. BlueScope in particular has been pushed to the brink with the strong dollar and was forced to recapitalise its balance sheet at the end of last year. It is unsurprising 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 Aussie dollar. It allows them to be lower cost producers of these products and more competitive against other nations.

However 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 sector that imports a large share of its goods from China but prices 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 though 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 does take a tumble it will be on the back of lower domestic interest rates which would work as a stimulus for spending by the debt laden general public.

No discussion about the currency's impact on the stock market would be complete without acknowledging the happenings of 2008. The Aussie dollar dived almost 40 per cent against the Greenback in just 3 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. If this scenario was to happen again, don't bother about buying any shares. Stick your money under the mattress.

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