A Short AUD/USD Strategy

 |  Includes: FXA, UUP
by: Hedge Fund Live

The Aussie has been on a massive run against the U.S. dollar for a while now. Recently, the Aussie crossed over the parity line, but I believe the run may end here and fall for at least a few months. Here’s why:

  • The floods in Queensland are going to disrupt coal, iron ore, and copper exports to China, which is Australia’s biggest trade partner. Queensland is responsible for roughly one-third of Australia’s coal output. This should weaken the commodity currency for obvious reasons.
  • The floods cover an area approximately the size of Germany and France combined or 398,405 sq miles; Queensland is 668,207 sq miles. This means the floods are covering close to 60% of the land in one of Australia’s most populous and most productive states. Queensland is not only a huge exporter of coal, it also exports meat (cattle), and sugar which need open dry land.
  • China recently hiked its central interest rate to slow inflation. This will also slow the Chinese economy. Although the U.S. was able to pressure China into letting the yuan float more freely, analysts gauge that this will not exactly be at the top of the Chinese priority list throughout 2011. The appreciation in the yuan is already starting to show results, with China releasing weaker economic data lately. (The rate hike is hypothetically bad for the Aussie because it slows a trading partners economy; the free float is hypothetically good in terms of export demand from Chinese).
  • Due to the floods, the Chinese and Japanese have reportedly had to switch to Canadian and Russian resource suppliers. Traditionally, contracts in this sector will last for months at a time, maybe longer. It may take a while before the Chinese can fully penetrate the market again.
  • Some analysts are predicting the Aussie to continue momentum against the USD in 2011. They are basing their opinions on rising commodity prices. I agree in regard to the price of oil, industrial metals, and natural resources increasing, but don’t think it will be beneficial for the AUD right away. As global manufacturing picks up, countries who export commodities such as Australia will be able to charge higher prices because demand will naturally increase. However, in this situation, Australia will not have the same capabilities it has had recently to meet that demand. (If you’re paying attention, this is when the lightbulb should go on for you to look into investing in commodities; this is due to increased demand worldwide and slightly diminished supply.)

Technical analysis of the AUD/USD spot rate chart will show the Aussie is bouncing around parity, the 1.00 level. Parity is a major psychological level, which in currency trading is very important to understand; there may be a lot of stops and limit orders hanging around this area causing price anomalies. The pair is in a major uptrend, but may be showing the first sign of a double-top at the 1.00 level.

When playing currencies, it is necessary to remember that you are investing in TWO currencies, not just one. While I would like the AUD to fall, I also believe the USD will be a stronger currency in 2011. With the U.S. surging as the leader of the global recovery, numbers and data should continue to get better, pushing the U.S. dollar higher against its Euro, Yen, Aussie, and Yuan counterparts.

Another near term strength for the U.S. dollar is the possible equity index pullback. That should happen in January and may last into February (according to my research on the VIX). This will cause temporary investor flight from equities to dollars/gold and possibly into bonds. The “risk on” and “risk off/averse” intermarket tendencies of the last year will show how the U.S. dollar (currencies), gold and equity indices correlate.

There are other ways to play this analysis besides commodities or straight up currencies. Shorting Aussie insurance companies who won’t be able to handle the sudden amount of claims is one way. Shorting Aussie (based in Queensland) mining companies and even going long in foreign miners such as a company from Canada with no exposure in Queensland, yet also has connections to China, are other ways to play this.

I’m shorting the AUD/USD spot (also available in futures and E-micro futures) based on the natural disaster, the Chinese slowdown and the U.S. recovery.

Any feedback is much appreciated. Thanks.

Note: I do not trade currencies professionally, do your own research. Keep in mind my research was done using Google and reports on news websites, so it may be inaccurate or biased. Currency trading can backfire for any number of reasons including natural disasters, unseen wars/conflicts, political situations, and surprises in other asset classes (flashcrash of an equity market).

(Click to enlarge)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.