Is The Australian Dollar Due For A Rally?

Includes: FXA
by: Ralph Shell

It has been a long slide for the Australian dollar ( FXA) which began about the middle of April. At that time the Australian dollar was trading above the 1.05 handle. The sell off took the market under 88.50 in early August. Since then the Aussie has been trying to mount several rallies which have stopped just above .92. As we approach this level again, can we now work through this resistance?

Looking back, the Chinese sponsored commodity boom, which enabled the Australian economy to escape the ravages of the last recession, was a mixed blessing. The Chinese building boom, a Keynesian spending plan, designed to provide employment, expanded past the typical roads and bridges investments, but moved on the high rise condos surrounded by ready made cities.

Naturally the demand for Australian commodities, specifically iron ore and coal, rose, as did the price and eventually the cost of labor. In economics, this is called The Dutch Disease. With the disease, robust demand for commodities elevates the cost of labor.

The Australian minimum wage went to about A$16.00 per hour, which of course resulted in the loss of manufacturing jobs. No longer could you manufacture anything in Australia and sell to the export market. Further, the Australian population of only 23.2 million is too small to support almost any manufacturing. Local production of Toyota cars and Holdens slowed to a near stop.

Just as the commodity boom began to slow, then PM Julia Gillard was successful passing a carbon tax and a mining super tax. Chances are this hastened the contraction of the commodity boom.

During the boom times the RBA increased the bank rate to 4.75% in 2011. With the highest bank rate in the developed world the funds flowed into Australia taking the A$ to the top side of 110. It looks like in retrospect the Aussies over played their hand but now with the bank rate at 2.5% the demand for Australian bonds is back. Or perhaps it is demand for the Australian Dollar.

At an August 2013 bond auction, Reuters reports:

"Australian government bonds to snap up all the A$1.6 billion ($1.47 billion) on offer, in a highly unusual and expensive vote of confidence in the country's debt.

Dealers were unsure if it was the same buyer at each sale, but they suspected it was, raising the prospect that a foreign central bank or sovereign wealth fund was the unknown bidder......

It would be a positive for the Australian dollar, and could be one reason it has rallied recently after several months of losses. The Aussie dollar was up at $0.9213 on Monday after bouncing from three-year lows under 89 cents touched just a couple of weeks ago."

The economic news coming from Australia is improving. On Sunday its Building Approvals were 10.8, up from last month's -6.3%. On Tuesday the Reserve Bank of Australia kept the bank rate at 2.5%, and indicated going forward it would remain unchanged.

As we approach the .92 handle , we wonder if this is enough rally for the minute. But then again the latest COT Report showed the specs were short over 91k contracts. Such a large short position probably means support on the top side of .90. Trade above .9225 probably means there will be some short covering.

Perhaps the current case of Dutch disease is over but going forward it may return and that is not all bad.

"Ten liquefied natural gas projects across the nation -- three of which are operating and seven under construction - will boost budget revenues by A$11 billion ($10 billion) a year from 2015 to 2025, according to estimates compiled by McKinsey & Co. Inc. The projects will add 2.6 percent to Australia's gross domestic product, or A$5,500 per household each year, and support 180,000 jobs, the New York-based consultancy forecast."

Remember China is making the transition to LNG rather than diesel or gasoline for transportation. China now has 1.48 million vehicles that use LNG, compared to only 135K in the US where we have a surplus of natural gas. The future of the Australian Dollar long-term looks quite strong.

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.

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