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Where is the AUD headed in 2010?
Yesterday, the Aussie dollar index broke below a key technical support level of 89.89 which was the most recent low on 28 Oct 2009. From the chart below, you can see a “head and shoulder” chart pattern (not a classic textbook one as there appears to be three right shoulders). The “head” is marked by a high of 94.06 in mid November 09. Yesterday the index closed at 88.77 which is firmly below the “neckline” of the head and shoulder pattern which normally signifies a confirmation of this pattern.
Many Australian investors may be wondering why the Aussie dollar has been falling in recent days, despite interest rate hikes by the RBA in early December 2009 which normally increases demand for the AUD as this means higher yield for investors. I used to be perplexed by seeming contradictions like this, until I started to look at the bigger picture which is the direction of the US dollar. If the US dollar goes up against major currencies like the Euro or Japanese yen, our dollar tends to go down. This is because most commodities are priced in US dollar and if the US dollar is strong, commodity prices tend to fall. To the rest of the world, the AUD is largely seen as a commodity trade and our dollar tends to move in tandem with the prices of commodities. Since realising this, I prefer to watch indexes like the $DXY, which tracks the US dollar against a basket of currencies as moves in the US dollar has a bigger impact on our dollar than local events such as RBA interest hikes or GDP growth reports.
So the next question is, why is the US dollar getting stronger? In the last US Federal Reserve meeting on 16 Dec 2009, the Fed decided to keep interest rate at near zero and indicated that they plan to keep it there for some time to come. Why would anyone want to own US dollars which does not pay any interest? We are also constantly reading in the news about how bad things are in the US especially with their huge public debt which recently hit 12 trillion dollars. What we don’t see in news headlines is how much worse the debt levels are in many other countries. Until the announcement from Dubai World, most of us had no idea about how bad Dubai’s debt problem was. Since then, there has been a lot more attention paid to sovereign debt. As highlighted in this article “Is sovereign debt the new subprime?”, defaults in sovereign debt can have a bigger impact globally than the defaults in subprime debt in 2007. A new acronym called PIIGS has been coined for countries with the biggest debt problems. PIIGS stand for Portugal, Italy, Ireland, Greece and Spain which you would have noticed are all in Europe. The debt problems in Europe has caused the Euro to fall against the US dollar. Even though the US has its share of problems, it is still seen to be less risky than a lot of other countries so the US dollar is still seen to be a safer currency compared to many other currencies. If you believe in technical analysis, you would have also noted that the US dollar has been showing signs of “bottoming” for some time. The folks at Elliott Wave International have been talking about this since August 2009 (check out our ElliottWave page for the latest information).
If you (like me) are bullish on the US dollar in 2010, there are a number of investment options. You could buy shares in a bullish US dollar Exchange Traded Fund (ETF) such as UUP which will increase in price if the US dollar goes up (see my Dec 16 post for more details on UUP). If you think of your wealth in AUD, then you can potentially profit is two ways. Firstly, you can profit from capital gains in your UUP shares. Secondly, you can profit from the currency exchange rate. For example, if you buy UUP at USD 22.50 per share when the exchange rate for 1 AUD is US 90 cents, your cost for 100 shares is USD 2250 (22.5 * 100) or AUD 2500 (2250 / 0.90). If UUP goes up as you hope and you manage to sell your 100 shares at USD 26.50 and the exchange rate for 1 AUD is US 65 cents (based on prices of UUP and exchange rates in Mar 09), you will get a capital gains of USD 400 ((26.5 – 22.5) * 100) and exchange rate gains of AUD 961.5 (2250 / 0.65 – 2500). Your total gains in AUD is 1577 (400/0.65 + 961.5), a 63% profit! If you don’t have the facility to buy US ETFs, then you can open a US dollar account with an international bank like HSBC, or buy US dollar bills but you can only profit from the exchange rates but will not receive interest or capital gains. As always, this is not a trade recommendation. Do your own due diligence and invest accordingly.
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[...] 2009. The only shares we now have are in defensive sectors (e.g. telcos and health care). I am also bullish on the US dollar so I have been moving more funds into our US brokerage account since late last year. Some of the [...]