Australian dollar gold standard

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Macro Afternoon

We have discussed the possibility that the Aussie has been re-rated by international investors and traders a few times here on Macro. We’ll won’t really know if this is true until the next big bout of market instability, but there is evidence that it is the case among long term holders such as central banks who have never bought Aussie before.

It’s one of the reasons why I think the next big sell off is into the ’80’s not anywhere near the 2008 low (sorry Rota 🙂 ). The reason I think the Australian dollar has been rerated is analagous to gold’s rally. People, traders, investors are looking for a long term stable store of value.

Here’s my rationale. In a fiat money world there is never any guarantee that the value on the front of the note will be maintained in real terms. Which ultimately is what big long term investors are interested in. So you’d be looking for a store of value that matches the prospects of the global economy, with less volatility if you can get it, and an ability to move in and out as you need.

In the past this was clearly US assets and the US Dollar. But even my kids know that China is where it’s at now, and with the epicentre and driver of global growth switching to Australia’s part of the world, global focus is following it. You can’t exactly get long the Chinese renminbi in the amounts that investors desire so what’s the next best option? A country that is interconnected with the region and has a big liquid currency.

So it might be a dirt and rock (iron ore and coal) standard but it is no less precious.

However, it’s not just about rocks and dirt because our economic stability is also a precious commodity to investors, as is the independence and track record of our central bank, our governmental debt and fiscal position and the stability of our political system (notwithstanding the current parliament).

Kerry Duce, who is Senior Credit Strategist at the ANZ, put out a piece this morning which was the catalyst for this blog and to a certain extent concurs with our view here. Kerry is a free thinking market/economic strategist and I always like to read his stuff. He reckons he has identified a new currency cabal. Here is a swathe of his piece.

  • The AUD – The new safe haven, or member of a new safe haven club!
    • Base metal prices have corrected sharply and in line with the sharp decline in our lead
      indicators, however in contrast to 2010 this correction has not translated to a broad
      based correction in spread markets or commodity FX markets (the AUD).
      This morning we find that support for the AUD is part of a broader FX story (a new club) that is not
      anchored by commodities (eg. CAD has weakened, whilst AUD has moved with Asian currencies).
    • the sharp correction in copper has not been reflected in a sharp correction in the AUD.
    • We had previously seen a period of AUD support and a sell down in copper in early 2007, following stronger copper and a weaker AUD in 2006.  The period leading into the financial crisis was marked by large and divergent swings in sentiment across asset classes. In 2010 both the AUD and copper corrected in tandem.

However, when we cast our eyes a little wider the resilience of the AUD is not alone – it is a member of a club, but the question is what is the entry ticket to this club if commodities are no longer the prime driver.  We think yield.

Regular readers will know that yield or yield differential is one of the key drivers in our currency valuation model but it is not an enduring support for the Aussie if we are arguing that it might be part of the new gold standard. But, when we look at the underpinnings of why rates in Australia might stay persistently higher than rates in other jurisdictions, and may need to move even higher still once the global economy strengthens, the RBA’s bias to raise comes to the fore and we could conclude that this lends further support to the Aussie for the long term.

Equally, in the minds of the investors who are in the Aussie already, for the long term and unlikely to get spooked out, I’d argue that the drivers of this “excess yield”, if I can call it that, are a self reinforcing positive feedback loop. That is, exposure to Asia and demand for Australian exports keeps labour and productive capacity in Australia tight for the long term supporting both the economy itself and interest rates (to the point anyway where the domestic economy is overly weakened by the strong currency).

So, are we a new gold standard? Sort of, with any doubts about it offset by other drivers of value.

What this means is that when the sell-off comes, as I think it might sooner rather than later, the dollar is unlikely to fall as far as it has during genuine ‘risk off’ episodes in the past. That means that for Australia and Australian industry we have to start to adapt to a currency that is probably going average at least 15 cents possibly 20 cents above the post float average in the mid 70’s.

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  1. “It’s one of the reasons why I think the next big sell off is into the ’80′s not anywhere near the 2008 low (sorry Rota ). The reason I think the Australian dollar has been rerated is analagous to gold’s rally. People, traders, investors are looking for a long term stable store of value.”

    Thats OK. Thats what Trailing Stops are for 😉

    Have you accounted for the possibility of China having a 1920s Japan type implosion? Also, Leith has written a great piece today on Chinese Banks and credit issuance (Japan 1920s!!).

    What about $300B being wiped off the slate (banks, housholds etc) with a decent property correction?

    • Deus Forex Machina

      Yes the trailing stop is your friend – that doesn’t matter if its you right or me, you’ll catch the bulk of the move.

      I guess my underlying premise is that where China is now is more where Japan was in the late 60’s early 70’s. So we have a decade or more of growth to come before things get structurally tenuous.

      I admit I haven’t studied Japan in the 20’s but I will now…thanks

      I guess I sense a Chinese mis-step coming but its cyclical not structural so for me should represent a buying opportunity…but like you I’m going to try to ride it down till it ends.

      For our business/corporate style readers the challenge is letting importers know to be careful up here in the short medium term and helping exporters know when to lock in cover when AUD falls…

      my challenge anyway 🙂

      • MontagueCapulet

        “I guess my underlying premise is that where China is now is more where Japan was in the late 60′s early 70′s”

        Maybe Japan in 1990 is more accurate. Japan in the 70’s had decades of exporting to the USA to look forward to. China has pushed the export-led growth model as far as it can go, but the model is now broken as the USA and Europe are past their demographics peaks and suffering from a post-bubble malaise which may take couple of decades to sort out.

        Since 2009 China has been trying the “bridges-to-nowhere” infrastructure program that the Japanese used to so little effect, but they’ve made it work for a couple of years due to the shear scale of the stimulus and the fact that some of their programs are actually useful (high-speed rail and highways). Some time in the next five years they’ll run out of useful projects and their resources demand will level off as a result.

        The transistion to a sustainable domestic-growth led economy is going to be the work of decades because they don’t have a sizeable middle class yet. I believe they can keep growing indefinetely, but they are going to have to shift down a couple of gears now that they have pushed the export-led model to its limit. Think 4% growth rather than 8%. And expect some major disruptions during the transition to a slower growth model.

        • Deus Forex Machina

          I guess I reckon China exports to itself via the infrastructure boom which as you say will take decades…they have used the consumption of the west to get them to the stage where they kick on internally and sustainably…

          so I dont agree that china is japan in the 90’s

          but asa ever we’ll keep studying it and if your right I’ll put my hand up as soon as I see it…

          major disruptions are a given though as you say…but for me at present and in prospect for the medium term they are cyclical IMHO FWIW

          cheers DFM

  2. With large US dollar holdings thanks to having worked there I hope you’re right.

    While I have reasonable success predicting other things, for me the movement in Forex is one of life’s two big mysteries. The other is how free kicks get paid in ruck contests at boundary throw ins — totally mystifying.

    Forex to me seems like alchemy.

    BTW do other readers get emails from business spectator whoring get rich quick forex schemes. If you believe the emails BS send on behalf of their pimps, anyone can make money from forex and quit their jobs.

    • Deus Forex Machina

      FX is a funny business…if it was a sport most participants would get sent off because they are trying to play the man playing the man and often don’t know where the ball is…too many off the ball incidents

      but if you do your homework and have well placed and realistic stops (know where you are getting out before you get in) it can be a good fun business

      as for the spruiking of the FX portals…many are the modern day equivalent of bucket shops…there was an article in barrons a while back saying that over 59% (i think) of small time fx punters get creamed

      fx is the best fun in the world but you have to do it properly and with the right amount of homework…no one would run onto the ground for richmond palying my beloved Magpies if they weren’t up to scratch physically and mentally, they’d get creamed.

      But that’s what they do ewvery day in FX land…silly

      • What he said.

        As an example, I bought GBPJPY (buying Pounds with Yen) on TA* 7 hours ago @ 130.970. Its now 131.790 and my Trailing Stop is 130.500 locking in 53% gain (on margin) in 7 hours.

  3. I’d urge caution on the Aussie (I note the current government exception), but we have a government barely holding together (policy madness), and the Green’s part of it does not favour mining, and that situation looks to be getting worse.

    Survey the mining MD’s and you’ll discover the risk profile very quickly. Canada’s Fraser Institute rates our sovereign risk as getting worse by the year with this current government, and that matches the information I hear from talking to mining MD’s. Martin Ferguson is doing the best he can, but he soon won’t have much of a say. The big miners continue on as they have the mass to do so, but it’s getting harder for others.

    Any global slowdown in commodities will see the AUD fall in my opinion.

    I totally agree on a flight to safety, and on the upswing there is good money to be made, but that can change in a millisecond, and you can wake up to a new world of pain. Even China is moving to ECB debt, but as reported today a 4.23% drop in asset value would see the ECB entire capital base wiped out. Risk is definitely on there.

    I can’t see the Aussie in isolation, so we have lots of risks to mining, housing, etc.

    Also, most likely won’t happen, but if the US did manage to cut spending and be fiscally responsible, IMO, overnight the AUD would drop significantly as would commodities.

    In the short to medium term I think the Aussie will be strong, and QE2 ending could push it higher.

  4. MontagueCapulet

    “It’s one of the reasons why I think the next big sell off is into the ’80′s not anywhere near the 2008 low (sorry Rota ).”

    You’re probably right, since the next big sell-off will probably be related to a commodities drop and occur sometime in the next 12 months while housing is still relatively strong.

    However, what happens in 2014 if housing is down 25% from the peak and, Chinese demand has leveled off and the commodities market is in oversupply due to increased capacity? Iron ore prices would be under $90 per tonne in that scenario, interest rates would be maybe 3% with a bias on the downside, retail spending weak and unemployment at least 7%.

    I think in that situation the Aussie dollar might go out of fashion in a big way.

  5. “What this means is that when the sell-off comes, as I think it might sooner rather than later, the dollar is unlikely to fall as far as it has during genuine ‘risk off’ episodes in the past”

    That’s only because these are not real risk-off events. The RBA is still not foreseen to cut interest rates. In 2008 the RBA was cutting rates at 100bps each meeting… and they’d do that again in a real risk-off event (Europe nations defaulting or something happening in Chine) and then you’ll see where the AUD goes 🙂

  6. To protect against the inevitable fall of the A$ one should be buying GOLD via Perth Mint -right now while the A$ is still at current heights. Most forget or don’t know that Gold in A$ terms was priced at A$1571 on Feb 20th 2009! The A$ was of course a lot weaker back then.

    BTW – once an A/C is established with PM
    it’s only a phone call to buy or sell with $ in or out within 2 business days.

    Pretty flexible for my money/S/Fund

  7. So come the end of june and theres no immediate QE3 what will happen to the AUD?? I can imagine what will happen to stocks and commodities.

    • Deus Forex Machina

      hey hey…

      don’t disagree

      my point is not that AUD wont ever go down its that there are a bunch of owners who wont necessarily run for the hills like every one always has when things go awry…

      to the extent that marginal players set the price it will fall but “value” is now higher than it used to be…

      at least it looks like it is???

      cheers DFM

  8. A bit off topic, but interesting how the AUD has become such a proxy for global risk appetite. Was talking to a global macro hedge fund manager here yesterday and he was telling me how he has loaded up on AUD/JPY puts as a tail risk hedge. No idea how prevalent this is, but just thought it was interesting…

  9. Mind you, too much more of “the RBA has left rates on hold” is, IMHO, likely to start seeing speculators and safe-seekers getting out of the AUD early, as they start sensing a “top”.

    My 2c

    • “Sensing a top?”


      FX traders drive the world mate.

      $3 trillion a night PLUS. 30% (worth) of Australia’s GDP gets tossed around A DAY.

      That top is over. 1.045 is the near watcher.

      • I meant yield top.

        ie. that interest rates are less and less likely to go up, so there is less and less significant/risk gains to be made from speculating on AUD/USD on the upside.

        Additionally, for the safe-haveners looking for IR yields on their AUD holdings, things are flat, and looking flatter, with a sense that the next IR move is down – which means less yield on their safe haven.

        With these psychological considerations, and the likelihood that the next RBA move will be to hold again, I would expect to start seeing a steady exit from the AUD, for the above-mentioned reasons, from those who wish to “sell on news”, and get out whilst the going is still pretty good.

        My 2c

  10. @Jarrod -How do you avoid paying GST on your purchases? I am tempted to buy but don’t want to give the government anymore of my money via tax.

    Gold is subject to CGT so after being held 12mths only 50% of gain is taxable.That’s 50% better than being in Cash wher 100% of interest is taxed.

    To really cream it hold GOLD in a Self Managed Super Fund -then pay only 15% tax on the gain. The SMSF bit is a lot easier than most realise. Hope this helps.