Australian Dollar Decline Set To Continue

"We think the Australian dollar will come down and will come down hard. It's expensive"

Stanley Druckenmiller (George Soros's ex-chief strategist)

For those of you who acted upon my recent Seeking Alpha article suggesting it was time to sell the Australian Dollar you will have had a profitable month. Since writing at the end of April the Australian Dollar (NYSEARCA:FXA) has fallen sharply from 1.05 to 97 cent - a drop of over 7%.

The important point to realize is that the Australian dollar's decline has only begun. It has far further to fall. The fundamental reasons why it will continue to decline sharply are still in place.

These include:-

  • The boom in commodities has crowded out the rest of the economy. The Reserve Bank of Australia (RBA) realizes a much cheaper currency is needed to stimulate growth and exports in indigenous manufacturing and services. These areas have become uncompetitive as the cost of living has increased and wages growth has become excessive. Australia's non-commodity sector is not competitive while it retains such a strong local currency.
  • Australia retains the largest intact property bubble in the world. All the other major global property bubbles (e.g. US, Ireland, Spain) have experienced significant deflation and even collapse. This hasn't happened in Australia yet. The country has some of the highest real estate prices in the world, relative to incomes. It consumers are over-leveraged and its four main banks (all systemic) are heavily exposed to any loans defaults. They are also very dependent on foreign financing for their business operations which puts them in a particularly perilous situation. A slowing economy will bring the property bubble and the banking sector into focus (as happened in the US and across Europe over the last few years). The RBA could easily be called in to backstop a bank in trouble.
  • Australian economic growth is closely linked to the Chinese economy. For the last two decades China has been the motor for Australian growth. However China is starting to experience a gradual structural slowdown as it moves from an investment and manufacturing economy to one focused more on services. This will have a significant impact on the Australian economy. Commodity growth can no longer be guaranteed so economic expansion will have to come from other areas of the economy. The RBA recognizes this and is trying to force the currency lower by reducing interest rates and spurring local industry.
  • While commodity prices will do well long term (due to massive increases in world population and economic growth in the developing world), the next couple of years is likely to see relatively soft commodity prices across the board. This means less demand from China, the suspension of many mining projects (which is already happening) and a generally more difficult time for the Australian dollar, as one of the world's major commodity currencies.

In addition, the few weeks since my last article was published has seen a number of negative developments which will accelerate the AUD decline.

  • The RBA has reduced interest rates again to a new low and the markets seem to be realizing just how expensive the AUD is. Currency speculators are circling as the market smells blood.
  • The U.S. dollar has been strengthening recently and this is set to continue if the Federal Reserve's starts to wind down its Quantitative Easing programme.

Between 1990 and 2006 the AUD never got above 85 cents to the U.S. dollar. Its long term historical average is in the region of 75 cents. I expect the Australian dollar will be trading below 90 cents by the end of this year and could be as low as 85 cents to the U.S. dollar.

Of course currencies often overshoot when they experience violent movements so my estimates could even be conservative. Either way the decline of the Australian dollar is set to continue.

Disclosure: I am short FXA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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