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The bulls in the Australian Dollar have been involved on the long side of the A$ going back to September when the Fed announced another version of QE. Continuing in January 2013 when the collective wisdom of the funds was that commodities should be part of the 2013 "asset allocation," the longs in the A$ grew. If commodities are a good long, why not buy the currency of a commodity producing country?

Australia, as a major producer and exporter of iron ore, coal, gold and wheat was a perfect fit. With the Fed's Bernanke expanding the money supply by $85B per month, those closest to the recipients of the new money were able to borrow an ample supply at near 0% interest. No doubt Chairman Ben was happy to see his new money reflate prices.

At the same time the Japanese were deciding to put a new PM in office who was dedicated to install officers at the Bank of Japan who would imitate the Fed. Rather than Japan's continued deflation, the new PM Abe would target 2% inflation as his goal.

We have also had buying of the A$ versus the yen. Toward the end of November, when it looked like Abe would be elected, the Australian Dollar versus the yen gaped higher, and this gap has yet to be filled. This gave us a bull run on the AUDJPY from 84.34 to 97.36. Only this week have we had a reversal in that pair. We first print a new high and then reverse with the pair now trading at 93.66. The gap remains far below.

Looking at the Commitment of Trader Reports we find that the speculative long at the CME futures market in the A$ climbed to almost 119K on the January 22nd report. At that time the open interest in the futures market was a very large 221K. The last report, 02 19 2013, shows that the open interest was down to 172K, and the speculative long had been reduced to 46.2K.

As expected the long selling took us down a little below 1.02 today. We suspect the liquidation has continued as we approach the low of 1.0150 last October. Part of the selling at that time was prompted of fear the Chinese construction boom had ended and their economy would contract. Iron ore, which has been Australia's biggest export earner, had sold off to about $100/Metric Ton delivered to Tianjin, China. The market for iron ore has since recovered to over $150/MT delivered to China.

The Australian economy has suffered from a severe case of Dutch disease. This happens when the commodity boom elevates wages and the currency, causing the manufacturing sector to suffer. With wages about $16 per hour it is difficult to produce and export, and with the A$ high it is cheaper to buy imports. For example the new imported Mercedes A Class, at a little under $36K, is less than some models of the domestically priced Holden. Sales of the Mercedes are brisk.

We are inclined to think the selling in this pair (AUD/USD, FXA) has about run its course. Perhaps there will be a final thrust lower, checking out the lows made in early October. Should this area hold a dead cat bounce should be in order with an initial target of 1.0350.

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Source: Can The Australian Dollar Muster A Dead Cat Bounce?