Australia announced a second consecutive trade deficit in February. The consensus had been looking for a rebound back into surplus territory, as the effects of the Lunar New Year holiday were expected to have worn off by now. However, iron ore exports only partially recovered from January's steep drop, and the value of coal exports fell again. Naturally questions are now being asked if this latest data point is yet another symptom of the Chinese slowdown.
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We all know that Australia has been a huge benefactor of the Chinese property boom. Its economy has been on a tear and so has its property market, some calling it a bubble.
In fact, should be a bubble, the country and its banking system could face huge problems considering that private sector debt is on par with Spain at around 300% of GDP.
House prices have started to drop:
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while consumer debt has not:
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and neither has government debt.
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In fact, unlike the U.S. as we have reviewed here, Australia as a whole is becoming more and more indebted to the rest of the world and at a very rapid pace ...
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Meanwhile, as China slows so does Australia as shown in recent PMI surveys coming in below 50 which are a sign of economic contraction ...
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So why has the Aussie been so strong? Well first as we have talked about many times, Australia's real rates have been constantly positive. Secondly, investors have use the AUD as a proxy for both the Chinese Yuan which is very difficult to access or to commodities because of the country's abundance in natural resources.
As you can see below, the correlation between the S&P 500 and copper has been perfect despite the AUD being 33% overvalued by purchasing power parity according to Bloomberg.
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Obviously you will not be surprised when I will tell you that the Aussie could be a great short. That would be especially true if China has a hard landing triggering a drop in copper prices or if the Aussie housing bubble pops. However, I am stunned by the resilience of both commodities and the Aussie and would therefore be careful. Instead of an outright short I would rather buy Aussie Short term debt in USD, except once again the market is already pricing in rate cuts since the Aussie 2 yr trades 100bps below the RBA target rate.
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But should China be the black swan, then shorting this overvalued currency while being long Aussie debt could make a make a very nice hedge! The Aussie could collapse while bond prices could shoot up if the RBA was to cut interest rates aggressively. All of this could be done while pocketing a relatively nice yield at currently 3.448%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
