Earlier in the week, while doing an analysis of the recent
I noticed something peculiar in the data for the Australian Dollar.
During the past six weeks the number of futures contracts held by
long speculators had ballooned from slightly less than 10K
contracts to almost 100K contracts.
Now, the fact that specs aggressively bought is not unusual. The
peculiar relationship is the minimal impact all this buying had on
the market. (AUDUSD, [[UUP]], [[FXA]]) Markets generally go in the
direction of the money flow. Concentrated buying moves markets
higher and selling sends the market lower. This market did go
higher, but not by much, and it has since reversed. Under the 1.04
handle, there may be more spec longs with a loss than there are
with profits. What if the specs have chosen the wrong side of the
market, and instead we are headed lower?
Let us reconstruct how we got here. Even those with only a
cursory awareness of the Chinese stimulus and consequent building
boom, know that Australian commodities provided the raw materials
for the Chinese recovery.
The biggest export to China was iron ore. The value of the ore
was 20/25% of
Australian exports during the last three years. When the Chinese
applied the brakes to their economy, attempting to negotiate the
fabled economic soft landing, the usage of steel and the demand for
iron ore slowed.
Iron ore has been supplied to China by Australian miners BHP
), Rio Tinto, (
) and the Brazilian miner Vale (VAL S. A.). To overcome the
additional 30 days of steaming time from Brazil, Vale introduced
what they named Valemax vessels. These massive bulk ore carriers,
over 200,000 tons, hastened the flow of ore to China just as the
economy started to contract. Now, iron ore is at a 2 1/2 year low
and recovery is a distant mirage.
For Australia, the boom in commodity demand has been a mixed
blessing. This is a classic case of what
"Dutch Disease, Negative consequences arising from large increases
in a country's income. Dutch disease is primarily associated with a
natural resource discovery, but it can result from any large
increase in foreign currency......"
For the Australian Dollar, the rally was dynamic. It moved from
a low close to .60 during the middle of the financial crises, to
above 1.10. As the commodity boom expanded, creating Australian
wealth, the Reserve Bank of Australia decided, in the name of
controlling inflation, they would raise rates.
This of course sent the Aussie higher. At that time, most global
economies were struggling, and money rates were low. Investors,
unable to find yield elsewhere, moved their investments to
Australia. As the money flowed into Australia, the Aussie moved
At the end of 2011, the Australian Office of Financial
Management estimated that 80% of the outstanding government debt,
over A$200B, was owned by non-Australians. Global market conditions
will influence whether foreign investors will continue to hold the
debt, or will they become frightened and move the money elsewhere.
Naturally a concentrated movement from Australia would hurt the
The remnants of the commodity boom may have contributed to bad
policies and possibly some expensive habits. During the good times
it is easy to be complacent, and forget that economic cycles do not
last forever. Last year Australia, by a slender margin, passed a
comprehensive carbon tax bill. The Greens may feel good about this
bill but for those producing or consuming energy, the bill is a
labyrinth of government policies.
The carbon tax in Australia is complicated, a tax on energy
producers and consumers. The government envisioned a high price for
carbon, thereby providing ample revenues for various welfare
projects. With carbon prices much lower than forecast, there is a
possibility that the grand spending plans may lead toward a
If the mining boom slows, as many expect, there will need to be
a revival of manufacturing activity which may prove difficult.
Higher labor cost, a strong currency, and the additional energy
costs because of the carbon tax will all hinder manufacturing
activity. With a population of slightly less than 23M, the domestic
market is small. Export markets are needed but will be hard to open
because of the elevated production costs and the elevated value of
the Aussie Dollar.
The Australians are also big spenders. Despite the commodity
boom, when prices were high and exports were soaring, Australia
still had a current account deficit. In the first quarter of 2012,
after the demand had started to slow, the Australian current
deficit was AUD14,892M. Since 2008, when the Chinese stimulus plan
began, exports were large, but Australia still had a current
account deficit in every quarter.
In a macro sense, foreign investments into Australia have
financed the current account deficits. Will this continue should
Chinese demand languish and the Aussies run a higher trade
We note, then, that the speculators are loaded up long the A$,
and have yet to be rewarded for the position. Longer-term, we see
some fundamental reason the currency can work lower. Events
elsewhere in the world may influence risk appetite and consequent
A$ demand. Next week will be interesting with the RBA meeting on
the 4th, the ECB Press Conference on the 6th, and the US payroll
reports on the 7th. We are inclined to use any modest strength to
sell the A$.
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I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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