The Australian dollar has a habit of making forecasters look foolish. How many times have you heard in the past few years that the Australian dollar, relative to the Greenback, is grossly overvalued and due for a large correction, only for it to trade stubbornly above parity.
The latest fall from a 52-week high of US$1.0624 to US96.54 cents – including a US9 cent fall in May alone – has commentators predicting further sharp falls. At long last, they might be right, although I expect a more gradual retreat towards US85 cents over the 12 months.
Betting on a sustained medium-term downtrend in the Australian dollar could be one of the smarter ways to make money, provided investors have the right strategy and products.
If anything, the risk is that the Australian dollar relative to the Greenback falls much faster than most economists expect, heading below US90 cents in a hurry. That would be good news for investors betting on a weakening Australian dollar.
But rather than second-guess which stocks will benefit from a lower dollar, or back unlisted funds that are unhedged for currency exposure, focus on gaining pure currency exposure. A simple strategy for those not familiar with currency trading is to use a currency ETF such as the BetaShares US Dollar ETF, which is bought and sold just like a share on the Australian Securities Exchange.
It aims to closely track the performance of the Australian dollar relative to the US dollar, before fees and expenses. If the US dollar goes up 10 per cent against the Australian dollar, the ETF is designed to go up 10 per cent too, according to Betashares. The ETF was up 8.2 per cent in May.
BetaShares also offers currency ETFs that track the British pound and euro. But stick to the BetaShares US dollar ETF (ASX Code: USD), given the relative strength of the US economy relative to the UK and Eurozone. The Australian dollar’s fall against those currencies will be less pronounced.
There are four main reasons why the Australian dollar should fall further relative to the Greenback. As I outlined in The Bull last week, the Australian economy faces a painful adjustment over the next 12-18 months as the resources investment boom slows and no other sectors grow sufficiently fast enough to pick up the slack.
This week’s poor gross domestic product result for the December quarter (up 0.6 per cent) was the weakest in seven quarters and further confirmation of a challenged economy.
The futures market is pricing in one more interest rate cut this year, but I expect at least two. An official cash rate of 2-2.25 per cent will further pressure the Australian dollar.
The second reason is continued falls in commodity prices. When commodity prices boomed between 2009 and 2011, the Australian dollar rallied, and the reverse trend is now firmly entrenched. Expect slower growth in China and further falls in key commodities such as iron ore and coal, which in turn will pressure the Australian dollar.
The third reason is sentiment. Twelve months ago, Australia looked great in the eyes of foreign investors who had watched our sharemarket underperform several other stgeloped markets. Today, this economy looks weaker as the resources investment boom slows and the economy muddles along. Sentiment from offshore investors towards the Australian economy and our dollar has turned.
The fourth reason is US dollar strength. Although its economic recovery remains patchy, the medium-term outlook for the US economy is improving as lower energy prices stimulate its manufacturing sector, and as the US housing market recovery finds new impetus. Watch for US unemployment to fall further as Australian unemployment rises in the next 12 months.
In turn, more global fund flows will work their way back to the US dollar, and the strength of that currency will put downward pressure on the Australian dollar, Greenback currency pair.
However, after sharp falls in May, consolidation in the Australian dollar is likely. The Reserve Bank’s decision this week to keep rates on hold, although widely expected by economists, takes some pressure off the dollar.
Long-term investors might disregard short-term price moves and add more US dollar exposure to portfolios via the BetaShares US Dollar ETF, which has an annual management cost of 45 basis points and is the only ASX-listed ETF that offers this type of currency exposure.
There are also diversification benefits for portfolios from adding different currency exposures that are less correlated to other assets.
Click on the links below to read other articles from this week’s newsletter
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.