With a trip planned to the US next year, I’m not exactly cheering on the fall in the Aussie dollar. Hotels, rental cars, food, shopping…everything becomes more expensive as my Aussie dollars become worth less.
RBA governor Glenn Stevens, on the other hand, is loving it. He’s been stressing how the strong Australian dollar is hurting us. Our economy relies on exports, so a weaker dollar is a blessing. It makes our exports more affordable to overseas buyers. This equals more profits, lower unemployment and a host of other benefits that validate the work of the RBA.
Since July, the Australian dollar has dropped by more than 8% against the US dollar. It’s fallen from a high for the year of US$0.95 to US$0.87 today.
When you hear about weakness in the Aussie, it usually refers to a decline against the US dollar. But the strength of our currency is not just measured as movements against the US dollar. Its real strength is measured by what’s known as the Australian dollar Trade Weighted Index (TWI).
The AUD TWI compares our currency’s strength against that of our trading partners. The major ones being China, Japan, the US, and the Eurozone.
Since July, the TWI has fallen too. But it’s down just 4%, compared to the fall against the US dollar of 8%.
The Aussie dollar is more or less unchanged against both the Japanese yen and the euro. It‘s down around 8% against China’s yuan, because the Chinese currency tracks the US dollar.
It seems the fall in the Australian dollar is more to do with US dollar strength, rather than overall Aussie dollar weakness.
Luckily for our exporters and for Glenn Stevens, US dollars and yuan pay for much of our exports. So a fall against these two currencies is good for many exporters. But there may not be such a benefit to Australian exporters with goods paid for in other currencies. And many importers will be worse off.
What’s next? Will the Aussie dollar continue to slide, bounce back, or remain where it is?
The dollar’s next move really depends on the health of the Chinese and the Australian economies, and whether the US will stick to its plan of letting interest rates rise.
A further slowdown in China’s economy will pressure the Aussie lower. Australia relies on China’s appetite for its resources, especially iron ore and coal. So a slower Chinese economy will reduce demand for Australian goods, and less money will flow into the Aussie.
A weaker Australian economy could mean even further interest rate cuts from the RBA. Lower interest rates mean lower returns on investments in Australia. This reduces the attractiveness of the currency to investors. However, lowering interest rates would fuel the already precipitous growth in house prices. And with the RBA worried about a real estate bubble, it doesn’t seem likely.
In the US, the Federal Reserve’s bond buying program has kept a lid on interest rate rises. The program is set to come to an end next month, opening the way for rates to rise.
A rise in US interest rates would push more money into US dollars. Money will move out of Australia and into the US and its ‘improving’ economy.
The Fed says interest rates are on schedule to rise in mid-2015. And a majority of Federal Open Market Committee members agreed that a rate increase will happen next year. The FOMC is the committee that controls US money supply and interest rates. Members expect that when interest rates do rise, they will rise more sharply than expected. This belief supports the high US dollar.
However, there are questions as to whether the US economy is strong enough for the Fed to let the market operate freely. If the Fed changes its mind, all this could unravel. Remember that the Australian dollar fell below 87 cents earlier this year. It then bounced back above 94 cents on talk that the Fed’s bond buying program would be extended.
Yet, the US Dollar Index chart (below) indicates the US dollar could sustain its rise for some time. The Index compares the US dollar against a basket of six global currencies.
After rising from around 80 in three months, the Index has broken above a strong resistance level at 85. It’s the first time since 2010 it’s been this high. This is a strong bullish sign for the greenback.
You can see that its rise since July has been rapid. Because of this, the Index’s Relative Strength Index shows the US dollar being a bit ‘overbought’. RSI is a momentum indicator that compares upward and downward movements in prices. A level above 70 is generally viewed as being ‘overbought’.
This means that any slowdown, or pause, in the rally might be seen as a time to sell.
Now back to the question: Will the Aussie dollar continue to slide, bounce back, or remain where it is?
The best anyone can do is guess. I’ve provided you with some analysis that can help make it an ‘educated guess’. But when it comes to preserving and growing your wealth, a ‘guess’ shouldn’t be any part of the equation.
Back to more important news — my upcoming holiday… If the Aussie doesn’t recover or continues its slide, my trip is going to cost me more than it would have just last month.
But there are ways you can take advantage of the lower exchange rate.
Without speculating on where it’s heading, the dollar’s fall offers plenty of opportunities. Opportunities with returns that will make up for the higher cost of my trip.
Around 30% of all Australian stocks are set to benefit, with their foreign earnings getting a boost from the lower dollar. If you want to benefit alongside them, look for Australian companies with a good share of their operations abroad — that is, exporters or businesses that report results in US dollars.
Consider a company such as Sims Metals, which generates 60% of its revenues in the US. Its earnings will be boosted when exchanged into Australian dollars.
Others with upside to a lower Aussie are healthcare group ResMed Inc., pharmaceutical group CSL Limited, and building materials supplier James Hardie Industries. And being Australian companies, you’ll receive any franking credits attached.
You can also buy high quality, foreign listed companies. But unlike investing in Australian stocks, you won’t receive any dividend imputation credits come tax time. And the currency benefits will only be recognised at the time you sell.
Another option is to in invest offshore through exchange traded funds or listed investment companies.
In early August, I recommended one of these funds for the Albert Park Investors Guild. I tipped a low risk, diversified US market index fund. In less than two months, it has returned 9.2%.
This is well above the 2.3% return of the S&P 500 Index — which tracks the performance of the 500 largest NYSE stocks.
Another one of my tips, a consumer products company, is up 0.8% in just under two months. But if you were to sell today, when converted back into Australian dollars, the return jumps to 7.4%.
Even if the share price had fallen, losses would have been offset by the gains in currency movements. If your portfolio is limited to just Aussie stocks, you’re missing opportunities such as this.
Of course, you should have compelling reasons to buy specific shares aside from expected movements in currencies. Your expectations may prove to be mistaken. The truth is no one knows where the dollar is headed — not in the short term and certainly not in longer term. If the Aussie dollar rises, your portfolio of international stocks will suffer.
The solution is to hold a diversified portfolio of quality investments. Balance your international stocks with local investments and a variety of asset types. You don’t need to predict when the dollar will rise or fall. Simply holding a variety of investments with different exposures will reduce your risk and give you the chance to profit.
For The Daily Reckoning Australia