The Australian Dollar’s strength over the past few years has been extra-ordinary. Sitting mostly above 1.00 against the US dollar for at least 2 years now the Aussie dollar is hollowing out the Australian industrial landscape by making it uncompetitive both on an international export level and here at home as imports are so much cheaper.
All the while it seemed that our miners were the culprit, or at least part of the problem, as the rocks and dirt we were selling to China was such a part of the bullish Aussie sentiment that pervaded the globes investors and reserve asset managers.
But no longer according to Fitch who yesterday put out a report saying that the Aussie persistent strength and rising “reserve currency” status (their words not mine) will ultimately hurt our miners too.
Fitch: Potential Aussie Dollar Decoupling Bad News for Miners
Fitch Ratings-London/Sydney-22 January 2013: The Australian dollar has an increasingly important role as a reserve currency. This could remove the smoothing impact that the currency’s historically strong correlation with commodity prices has had on the reported results of Australian mining companies, Fitch Ratings says.
The strong correlation between the Australian dollar and price of commodities such as iron ore and coal smoothed the results of mining companies and was of particular benefit when the performance of both was weak. Lower US dollar revenues from depressed commodity prices were partially offset by the translation of Australian dollar costs to the company’s US dollar-denominated profit statement at a lower rate.
However, Australia’s strong economic performance in recent years has increased the Australian dollar’s popularity as a reserve currency to such an extent that the International Monetary Fund is considering whether to include it in the fund’s regular report on foreign exchange holdings. Relatively high interest rates compared with other developed markets also continue to attract investors.
This demand for the Australian dollar helped the currency remain strong in 2012 despite a drop in commodity prices. This is likely to continue to support the currency in the near term and will add to the pressure we expect mining companies to face from a combination of cost inflation and stagnant commodity prices in 2013.
It is unclear if this decoupling will become permanent as economic conditions in other developed markets improve. But if it does continue, it will increase volatility in mining companies’ reported results as factors other than commodity prices have a bigger influence on the currency. The impact will be greatest on companies whose operations and assets are concentrated in Australia and use the US dollar as the functional currency, such as Fortescue Metals Group Limited. For the global mining companies like BHP Billiton and Rio Tinto, the impact will be mitigated by conservative financial and leverage profiles and by their commodity and geographic diversification.
Now you won’t be surprised to know that I don’t necessarily agree. I strongly hold the view that the Aussie is not a safe haven but rather a safe harbour.
Semantics you could say but I think the difference between Safe Harbour and Safe Haven is very important for the longer term outlook for the Aussie Dollar and the specific discussion that Fitch has raised above.
The safe haven idea means that the Aussie Dollar stays high regardless of what is happening here at home. That at times of economic turmoil the Aussie should rally and at times of economic sunshine the Aussie should fall. Kind of like the US dollar has done for years and the Swiss Franc has done over the past few years in particular.
But what safe haven also says, as Fitch points out, is that the Aussie dollar no longer follows the trends of our major exports, no longer follows the trends of our major exporters and now longer cares about relative interest rates between Australia and the rest of the world.
For a country with a persistent current account deficit to that notion I say poppycock.
Rather I note everything that I have said about the Aussie for a safe haven and say that the recent strength is a direct result of the weakness in the developed world and like the flows out of the Swiss Franc lately I say that when the economic sunshine comes out elsewhere or if Australia were to hit the skids economically money would flow away from Australia.
I simply do not believe that the Aussie has given up on the old drivers, certainly since the 2nd round of the European Sovereign debt problems broke loose in April 2011 the relationship has been weaker than in the past (see our long term AUD outlook from November – here)but even using these old drivers the Aussie is still within 1 standard deviation of the NAB’s (my old) Fair value model.
So can we really say that if Iron ore and coal tank, if the globe were to weaken or if Australia hits the skids the Aussie won’t react? At present probably yes – there are little alternative destinations for investors cash and even fewer where that destination has a triple A rating and a strong Central bank and Government balance sheet.
But do you think this is really a new paradigm? – I think not.
Have a great day.
Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor www.globalfx.com.au has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.