Finding high-conviction ideas in this market is hard work. Many stocks fall into two categories: those plagued by cyclical and structural challenges; and those that can grow faster than the economy and thus are priced well above their fair value.
I am more confident about a rising gold price and falling Australian dollar against the greenback over 12-24 months. I outlined a positive medium-term outlook on gold for The Bull in late 2014 and have reinforced that view several times since.
Heightened political and economic uncertainty, amplified by Britain’s decision to leave the European Union and the rise of Donald Trump in the US Presidential campaign, means demand for safe-haven assets will rise. Lower-for-longer US interest rates are another positive for gold and a reason for its rally this year.
The Australian dollar has to fall. Plenty of good judges believe our dollar should be meaningfully lower; some are even calling for US40 cents, from US75 cents. Currency forecasting is a mug’s game, but getting the direction right can boost portfolios in a low-return market.
Our currency has been stubbornly high, despite the Reserve Bank’s efforts to bring it down through interest rate cuts. Australia’s AAA credit rating (for now), official cash rate of 1.75 per cent and 3.1 per cent economic growth (which masks underlying weakness) are a beacon for foreign investors in a low-growth, low-inflation environment.
That could change. The Reserve Bank will surely cut interest rates in August, given recent weaker-than-expected retail sales growth and the prospect of waning consumer and business confidence after the election – not to mention bad economic news overseas.
A cash rate of 1 per cent in Australia, probably less, seems inevitable. Zero interest rates, while unlikely, cannot be ruled if Australia continues to suffer from global currency wars and has to cut rates more than expected, to get our dollar down.
Lower commodity prices will also help drive our dollar lower. Do not become complacent by iron ore’s gains this year and advances in resource shares. The global economy is slowing, risks are rising, and commodity supply is taking longer to adjust, in part because low interest rates are helping marginal producers stay in business, when they should be collapsing.
The risk of a shock to our economy is growing. A sovereign ratings downgrade is unavoidable if Australia’s budget deficit is not reigned in. That seems unlikely given the political stalemate and inability of politicians on both sides to cut spending or raise taxes. If this trend continues, foreign investors, who are partly funding Australia’s lifestyle, will require higher returns as compensation for higher risks in investing here.
A sharply lower Australian dollar, possibly below US50 cents, will be needed as a ‘shock absorber’ for our economy and as a catalyst to drive export growth and slow imports. Short of a growth miracle, our economy’s challenges will not be met with a currency at US75 cents.
Gloomy stuff, I know. But a 10-year Australian Government Bond yield at 1.84 per cent, after hitting fresh new lows this week, is cause for concern. The bond market is warning that Australia – and the world for that matter – faces low growth and inflation for years.
The bond yield suggests the economy will not able to cope with any interest rate increases, such is its fragility. Low rates of course are good for borrowers and they boost demand for high-yield shares. But they also signal expectations of a weakening economy that will eventually hurt corporate earnings and share prices. The sharemarket cannot be divorced from economic reality forever, despite the best efforts of global central banks.
I see our dollar drifting towards US60 cents in the next 18 months. It could get there in a hurry if the RBA quickens rate cuts and foreign investors become more concerned about our economy. Either way, the Australian dollar’s direction is south.
That represents an opportunity for investors. I was bullish on international equities, particularly US stocks, for The Bull in 2013 when the Australian dollar traded near parity with the US dollar. That idea performed well as the Australian dollar briefly dipped below US70 cents last year before recovering to US75 cents.
Chart 1: AUD/USD#FOTO:306865916:600#Source: Yahoo
This time, I prefer benefitting from a falling Australian dollar through pure currency exposure rather than international equities. Stocks should never be bought on currency considerations alone: a favourable currency view should be one of several considerations.
Don’t get me wrong: international equities deserve a bigger allocation in most retail portfolios. But this idea is purely about the lower Australia dollar. Using an Exchange Traded Fund (ETF) that provides leverage to a lower Australian dollar versus the greenback, without equity market and company risks, makes sense in this context.
BetaShares’ US dollar ETF appeals. It aims to track the change in the price of the US dollar relative to the Australian dollar, before fees and expenses. If the US dollar goes up 10 per cent against the Australia dollar (our dollar falls), the ETF is designed to go up 10 per cent.
Like other ETFs, the BetaShares US dollar ETF is bought and sold on ASX like a share. It is convenient way to profit from a view that the Australian dollar will fall against the US dollar, diversify portfolios and hedge against currency risk.
The ETF has a three-year annualised return of 6.6 per cent to June 30, 2016. It should do better when our currency stops defying gravity and better reflects our economy’s mounting growth challenges and debt problems.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness of the information, with regard to your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at July 6, 2016.