The Forgotten Benefit of the Aussie Dollar

Hands holding money - Australian dollar (AUD) banknotes - money raising, funding & consumerism concept

I’m always on the lookout for some good news here at The Daily Reckoning. So let’s kick off the day with some good news for copper.

Yesterday, commodities giant Glencore announced plans to sell assets and reduce debt in order to strengthen its balance sheet. It also announced the suspension of two of its copper mines in Africa, taking around 400,000 tonnes of copper out of the market.

Copper obviously liked the news and spiked 2% at one point in London trade. It closed about 1% higher. It might not seem like much, but on a day when most other commodities fell it was a welcome gain.

But the picture changes when you look at the long term price of copper through the lens of an Aussie producer. When earning revenue based on an Aussie dollar denominated copper price things aren’t necessarily all that bad.

They’re not great, but it’s not as though the copper price is in an endless downward spiral.

The chart below is a five year, weekly chart of copper denominated in Aussie dollars. As you can see, ever since plunging in the latter half of 2011, copper has traded in a broad range. It’s neither bullish nor bearish right now.

Source: StockCharts

To establish a new trend it needs to break out of this range. That could take a while yet.

The message here is that, for Aussie copper producers, things aren’t all that bad. The falling dollar acts as a cushion to falling US dollar prices. This is as it should be.

The stock market price action supports this view. In a recent special Crisis & Opportunity report, which you can read here, I nominated three stocks to buy. One was an Aussie copper producer. Despite the August market turmoil, the stock held up well. It remains in a strong upward trend.

While it’s not all unicorns and rainbows in the commodities sector, it’s not all bad either. There is some good value in the sector. Well managed companies with a strong focus on costs, combined with a falling Aussie dollar supporting revenues, means some stocks will do very well in the next few years.

But right now sentiment remains poor. You can blame China’s deteriorating economic situation for that. Yesterday, the Middle Kingdom announced that it burned through a record amount of treasuries over the past month in attempting to support its currency, the yuan. As Bloomberg reports:

China’s foreign-exchange reserves fell by a record last month as the central bank sold dollars to support the yuan after the biggest devaluation in two decades spurred bets on continued weakness.

The currency hoard declined by $93.9 billion to $3.56 trillion at the end of August, from $3.65 trillion a month earlier. Economists surveyed by Bloomberg had forecast a median $3.58 trillion. The yuan weakened in offshore trading and 10-year Treasury futures contracts fell after the data.

As I pointed out last week, China’s capital controls aren’t particularly effective, meaning there is a lot of capital trying to get out of the country. When your capital account is open, it makes it very hard to maintain a fixed exchange rate.

That’s why you saw China devalue its currency over the past month or so. China is trying to defend a weaker exchange rate. Still, they’re losing a lot in the way of foreign exchange reserves in order to stage this defence.

While China still has a massive hoard of reserves, it’s the change that is important to focus on. Because a fall in reserves (even from a high level) represents a drain on liquidity in China’s financial system.

I’ll give you an extreme example. Say someone borrowed US dollars and sold them to buy yuan and invest in a high yielding Chinese ‘shadow-banking’ product.

Due to the negative publicity, the investor gets cold feet and when the investment matures they don’t want to roll it over. They want to get out. So they sell out and now have yuan sitting in a commercial bank account. But they want to get it back out of the country to repay the US dollar loan. They sell the yuan for US dollars and take the money and run.

To supply the US dollars, the central bank must sell its US dollar reserves. In this way falling US dollar reserves also reflect falling deposits of yuan in the Chinese banking system.

That’s not particularly useful when you’re trying to manage a credit bust. China could close up their capital account again — and there are indications that it’s trying to do so.

But one of their economic reform aims is to ‘liberalise the capital account’ and make the yuan a more widely used international currency. They’ve spent years going down this path so they’re not about to renege on it now.

It comes back to the same answer it’s always been…there are no easy choices for China as it adjusts to lower growth and a less commodity intensive growth phase. Every policy choice will be a trade-off.

The reality for Australia is that we will be a loser in China’s transformation. It needn’t be that way. But with a dearth of political leadership and a rent-seeking population, we don’t seem prepared for the structural changes needed to make us prosper again.

Vern Gowdie thinks it’s the ‘End of Australia’. Maybe we need to get to the end before we can start at the beginning again?


Greg Canavan

Editor, The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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