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Glory Days for the AUD are Numbered

June 22, 2011 11:36 pm by Dean Morel

A long term perspective is the best cure for anchoring.

Above is the AUD to USD chart since the Australian dollar floated in December 1983. These glory days are numbered. The historically strong Aussie may stay above a US dollar for a brief period, but long term it will revert to the mean, no doubt overshooting on the way there. Same goes for the kiwi dollar.

Note: I’m considering an employment offer from a US company, so this view is biased.

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9 Comments »

  • Justin said:

    Agree with you there. Plenty of comments out there that ‘this time it’s different’ and predictions of $1.40 or 41.50 to the USD. Baloney I say.

    Having said that, I think we’re probably still a good 12 to 18 months away from seeing any reversal of the strength of the AUD. When the Fed starts talking interest rate increases, which is looking like late next year (maybe), I expect it to unwind pretty quickly.

  • Dean Morel said:

    Agree on the likely time frame, and more importantly on knowing some of the fundamental catalysts that will confirm an inflection change. Fed raising rates, Global slow down, commodity price falls, Australian recession, flight to safety for any of the many known or unknown reasons, purchasing power parity, the list goes on.
    Agree that $1.40-1.50 is incredibly unlikely. I see this as a great 3:1 return to risk opportunity with 30 cents lower on the AUD at least as likely as 10 cents higher, and am waiting for a compelling reasons to increase exposure to the USD.

  • Dean Morel said:

    Data Diary view http://www.datadiary.com.au/2011/06/23/australian-dollar-update-pressure-is-building/

    If…I think we can expect a stop loss frenzy on a break of 1.0475.

  • Tom Rishbol said:

    You might be right with your data if you want a medium-term look. But, for a better long term trend, analysts need to look back to before the Aussie was floated. I’m guessing that’s what Soros et al are doing. Even though it was previously a dirty float or fixed exchange rate, it was still based on a Trade Weighted Index determined by the RBA. And that, as well as the terms of trade, has indicated a much stronger Aussie for some time, even before the USD woes.

    If you include that prior data which included commodity booms that pale into insignificance compared to the mega boom we have now, you’ll see that the Aussie traded a lot higher, especially in the period described as the “Euro Dollar Overhang” when the USD had a sustained level of weakness near the end and after the Viet Nam war. We’ll have to wait and see if the Soros prediction of $1.40 comes true or whether Warren Buffet is correct in staying away (he thinks it could either spike up or really spiral down – not a profound forecast, but Buffet just thinks it’s too risky.) The former has an incredible record on currency dealing, the latter a pretty crummy one, even if he is seen as the best stock market investor in the world. He’s smart enough to stay away from things he’s not good at.

    There are undoubtedly going to be big swings with volatility, but the downswings will probably offer buying opportunities. Even with the bad news/good news swings from PIIGS news more recently, the downs have not been as big or as long as previous, or reacting as badly as previously on the Dow downswings. Where do you go for risk aversion? To a USD backed by a flagging economy and downgraded credit rating? The appeal of USD as a safe-haven destination is definitely diminished. Flight to Yen? Not a great appeal either, when you consider (last I heard) it took $2 or more of government debt (depending on who’s quoting the statistics) to create $1 of GDP even before the earthquake and nuclear crisis. EUR? Well people are still speculating about the long term survival of that currency — and all those PIIGS, and also individual country elections the EEC and its member countries have to pander to. CHF might be another, but it’s not a huge economy either. Canadian $? Another commodity currency like the Aussie.

    So these factors indicate there is going to be long term underlying support of the Aussie. Central Bankers are pretty smart guys, that’s why they’re reweighting their holdings with more AUD. That long term support will change only when there’s a pick-up in the US economy — and a demonstrated pick-up – with unemployment falling back to at least six to seven percent. Unless the US really gets its act together and inspires an export-oriented economy instead of a consumer-spending-driven economy, that’s going to take at least two years or more and they’ll most likely still end up with a Friedman-like “natural rate of unemployment” higher than pre-2008.

    And what if things fall off a cliff again with another financial crisis like in 2008? It’s still a possibility; but the flight to safety is more likely to be gold than USD or Yen. And if the numbnuts at currency trading touts like FXCM, Gain Capital/Forex.com, Saxo Bank et al continue to be believed, anything good for gold is good for the Aussie. What a conundrum.

    The only other thing to watch is FXCM SSI (speculative sentiment index) which has a solid history of accuracy. Use of SSI is where the market depends on all those poor little stay-at-home dads getting it wrong. (Forget the racial and sexist slur of the “Mrs. Watanabe’s” – it’s mostly men doing the trading, even if it’s the wives who go to the free FX promos and meetings and come clean about losses). SSI currently indicates more gains for the little Aussie battler.

    My money for the long term is on Soros.

  • Dean Morel said:

    Thanks for sharing your excellent insights Tom.

  • Sean said:

    I too would not use only post-float data.

    I was speaking to a friend at dinner a few months ago who invested a few 100k in USD on a currency speculation on the basis of mean reversion based on post-float data. I don’t think he has ever speculated in forex significantly before and I have no idea why he felt so strongly about this.

    The correlation between AUD and gold is very strong (0.85ish). In terms of sovereign risk, AUD would be lower than USD in terms of long term government default risk. My money is still 95% in AUD so I could have a cognitive bias.

  • Sean said:

    1.5 was the high in about 1974. It would be interesting to know what the peak was prior to 1970.

    http://commons.wikimedia.org/wiki/File:Aussie_exchange_rates.png
    http://research.stlouisfed.org/fred2/categories/287
    http://www.fusioninvesting.com/2010/03/how-to-invest-in-the-usa/

    It will be interesting to see what eventuates.

  • Paul S said:

    Hi If I call the peak in the AUD was about 1976 and was a result of direct government revaluation of the exchange. The peak was about 1.4950. I also saw a data series in a book produced for the bicentenary that had exchange rates dating back to 1840 – mainly Australian Sterling v English Sterling. As I recall the highest value for the AUD v USD was above 2 in the late 1800 or early 1900s.
    cheers

  • Oscar said:

    With respect, the AUD v USD is only going to increase over the next 3-5 years.
    The days of AUD/USD trading at below parity are probably a thing of the past and it is the huge US debt and entrenched fiscal deficits that require a lower USD, so these structural problems can be addressed.

    The AUD/USD is likely to rise to $1.10+ by mid-2013(ie June/July 2013).

    The AUD /USD may rise to $1.20+ within 3 years, as US money printing continues, and the USD falls so the US can effectively and sustainably reduce its deficits and debt, and grow its economy.

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