Australian Dollar Finally Rallies, But Will It Hold?

Includes: FXA, UDN, UUP
by: Ralph Shell

For the first time since June 13th the Aussie has had a rally of over 200 pips. The catalyst for the rally was notes from the meeting of the Reserve Bank of Australia. At the May7th meeting this body reduced the bank rate to 2.75 from 3%. The Australian dollar bears were hoping there would be another rate reduction to 2.5% but sadly for the bears the rate was left unchanged. The next meeting is scheduled to be held August 6th 2013.

Historically the Australians usually have a trade deficit, though there has been a surplus for the past three months. At the Reserve Bank meeting held earlier this month on July 2nd. they warned that the sharp reduction in the value of the Australian dollar might result in inflation as the cost of imports has increased caused by the sell off in the Australian dollar from 1.02 to .90. It will not be until the end of the month when we get the next report on imported prices, which might determine if their fears are justified.

Another reason why the Reserve Bank may be inclined to wait is because since the rate change, interest rates have been rising. Should global rates stay firm, it is hard to see the Aussie rates coming down. Perhaps Bernanke's Congressional testimony will provide clarification of the US policies, but best not plan on it.

Trading the Australian dollar always seems to be quite popular no matter the direction of the market. Further the market often is a trending market, which results in a big money trade.

If we look at the daily chart of the AUDUSD (NYSEARCA:FXA), the downside move began April 15th when the price was about 1.0380. This was also the approximate price of the 200 day SMA on that date. The 200 day SMA was not challenged as the Australian dollar fell to a low of slightly under .90.

It is interesting to review the COT positioning during the move. In the April 16th COT Report of futures and delta adjusted options, the spec long was 60.9K contracts. Now the latest report we have is July 9th where the specs are short 90.0K contracts. This is down from the record short position the previous week of 95.3K contracts. Each Australian dollar futures contract is $100,000 so this has been a big switch.

Looking at the weekly chart, it shows the intensity of the bear move. The 14 week RSI went to a low of under 20, a deeply oversold market. The Japanese yen was another contract that was a big loser to the USD. The RSI in the USD versus the yen did make it to 82, meaning the USD was seriously overbought. The result was a market correction of 900 pips from about 103 to 94 in a very short period. It is rare to see markets this over sold or overbought. When they turn, they often retract far more than might be expected.

We should remember a major reason why the Australian dollar was weak was caused by fear the Chinese, Australia's biggest trading partner, were headed for serious economic troubles. Yes, the GDP in China, if we can believe the numbers, is down, but they claim the growth rate is 7.5%.

As a big commodity exporter, Australia is keenly dependent on prices. Most commodities prices have rallied during the past month. Iron ore and coal are two very important Australian exports and there are reports it is not all bleak:

The good news for miners is that appetite in China and India, the two biggest drivers of global coal demand growth, will cushion the sector's decline.

The two nations currently account for around 30 percent of the world's global coal demand, with that figure remaining relatively steady through the latter part of the decade, according to a UBS forecast.

"We'll never really go back to the bad old days because (China and India) are two new kids on the block that aren't going away," said Tom Price, an analyst with UBS in Sydney.

Where do we go from here? Perhaps the AUDUSD is destined to trade in the mid eighties as some of the bears have said. The trouble is the market is quite short and the commodities markets are firming. The Middle East fear of oil supply disruptions has an impact on more than oil. We are inclined to watch for a minor pullback to buy, with a recovery target in the mid 90s. As always, manage your money.

Disclosure: 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.