A resurgent $A

A surprise this year has been the strength of the $A after it hit around 55c against the greenback in the COVID-panic earlier this year on the markets.Currently the Aussie is buying around 74c.

RBA-aud-usd-exchange-rate

Sourced from the RBA

There are likely two main drivers of the strength:

  • Unlike the US, our rates were already very close to zero (0.5%) when the crisis hit earlier this year. The US Fed had hiked rates over 2%, meaning that when both central banks cut to zero, it was a larger easing in the US, ergo downward pressure on the US dollar.
  • Commodity prices: have surprised on the upside, with record Chinese steel production boosting iron ore prices to massively profitable levels, currently around US$123/ton.  Other commodity prices have also done relatively well, nickel is another one benefiting from massive Chinese demand and optimistic sentiment over electric vehicles.

How much higher can it go? Well the first factor has played out, while the consensus is iron ore prices will moderate from current levels. Seemingly, ‘not much’.

However, forecasting commodity prices is notoriously difficult, no-one saw iron ore prices increasing 50%+ when the world economy seemingly shut down earlier this year.

The US election is also rapidly drawing closer which could be another key sensitivity. Escalating civil unrest in the US is a large and growing risk, compared to Australia. My money would be on Trump being returned currently, but it will be interesting to observe.

The positive of a higher $A is cheaper imports (which could flow through to e.g. cheaper electrical goods etc at retail stores) however it will also threaten the competitiveness of key services such as international education and tourism. At the moment that’s largely a moot point anyway due to travel restrictions.

The strength of the $A has been a pain trade for those unhedged in US markets, yet the recovery there has softened the blow. For overseas investors who bought into Australia at the March lows, they may have made a motza as equity prices moved higher with the local currency.

A resurgent $A

Counter-cyclical bets

A famous adage in the markets is ‘buy fear, sell greed’. Often the greatest profits are made doing what seems the most painful at the time.

When markets puked earlier this year, gold and crypto puked with them. As ‘safe haven’ bets this seems counter intuitive. Surely when people are selling stocks, they’d be putting their money in safe havens? Well history seems to point otherwise, the same thing happened in 2008 with gold selling off (initially).

However, now as then, safe havens have come ripping back up. Gold has hit all-time highs and is flirting with US$2,000/oz, crypto has come alive with Bitcoin currently around $11,000 – having flash crashed to less than half of that earlier this year. Suddenly 2017 highs are being talked about again; and with gold and the NASDAQ hitting all time highs recently, why not?

A falling US dollar and general fears of inflation are causing a rush into precious metals and crypto. Property is another real asset, but it has more of an interaction with the economy and so it’s less of a pure hedge. It’s no surprise this is happening, 2020 hindsight. Yet also quite foreseeable based on 2008.

That begs the question, where is the next uncomfortable trade? One which seems painful to think about entering into, not fashionable now, but in a purely rational sense has sound fundamentals?

I’d be lying if I said I had all the answers here. Or maybe the BTC/gold run is just starting still. However, what are some candidates:

  • Oil/LNG: there’s no doubt oil is down, but it’s very hard to be positive given the shifts towards renewables/electric vehicles.
  • Bank shares: Australian bank shares have been hammered over the last few years, most recently with APRA capping their dividends at 50% payout (so much for free markets). As mature businesses, their typically high payout ratios (let’s say 80% as a ballpark) make sense. There are less opportunities for investment and growth and so returning profits makes sense. What (positive) will damming that flow achieve longer term? An easing property market adds to the gloom. Yet there may be reason for hope if the economy/population growth can get kick-started again. Some of the banks are also innovating, e.g. CBA entering into a tie-up with an Afterpay type company (Klarna).

Hard to kill. My general approach to the market is to be well diversified. When crypto popped up again, even though I missed the trade, I still had a holding. I have resources, financials, tech, health. I’m hard to kill. That said I also swing harder on trades I’m confident on, too much diversification will give vanilla returns.

gold

Counter-cyclical bets