Part 1, the saga of the missing Aussie traders, was written on February 18th. Then, we noted there was a decline in the trading activity of the Australian Dollar at the CME futures markets, and the AUDUSD had just rallied from .86 to above .90. With the advantage of 20/20 hindsight we can confirm the market was over extended on the short side. The result was a short covering rally. Another month has passed and it produced another month of bearish disillusionment.
The initial set up for this bear trap goes back to December when the Reserve Bank of Australia Governor began talking the Australian dollar lower. He said an economic dow trend was inevitable, and suggested Australia would be better served by a weaker currency. Currency specs, according to the COT reports, had already been short the Australian dollar, and this was encouragement to sell more.
There was also an enticing macro theory which conceptually is bearish on the Aussie. Most Australian exports, about 60%, are commodities. Broken down by commodity exports recently, iron ore and gold have been 28% of the total, coal 18%, oil and gas 9%, and wheat and wool 5%. China is the biggest market for these exports. China was headed to a well advertised slow down, which was viewed as a reason to sell the Australian dollar. As mentioned earlier, there is a problem with this theory:
For many of the large traders the short Australian dollar was part of a macro view that the Chinese economy was slowing and this would hurt Australian exports. The trouble with this theory is the extreme time lag between the economic cause and the anticipated result. A policy change today may have little market reaction for months. The affected market will respond long after the move was anticipated by traders. Looking too far ahead is little help with nearby market action, especially if using too much leverage.
There is another problem with the conclusion a weaker Chinese economy will hurt the Australian economy. While China is the biggest importer of Australian commodities, they take only 27% of their total exports. Combined demand from Japan, South Korea and India, at 30% of the Aussie exports, exceeds the Chinese demand.
By the end of January the net spec short in the Australian dollar had grown to almost 87K contracts. The biggest short position corresponded, quite naturally, to when the market was close to the bottom.
The last COT report shows the spec short position is down to about 30K contracts. The pair has rallied over the .92 handle. As the market has rallied, the total futures open interest has come down. In late January the OI in the Australian dollar was about 139K. Through the trade on Monday March 24, the OI was only 80.6K. Historically, it was fairly common for the OI in the Aussie to match that of the pound or the Canadian dollar. Now the OI in the pound is 203K, and the Canadian dollar, 136K.
The Aussie bears have been taking their losses and getting out of the market. Today when Governor Stevens of the RBA declined to comment about the level of the currency, this prompted more short covering and a new high of .9244.
It is easy to focus on an anticipated reduction of Chinese demand for Australian iron ore and other commodities. The country down under, however, has other things working that bodes well for its future, namely, abundant supplies of natural gas.
Since Australia is located far from the countries that need this source of energy, the gas must be converted to liquid so it can be transported to market. Construction of a LNG plant costs billions and takes years to complete. Despite the brisk global demand for LNG, and fear of supply disruptions from Russia, there are currently only twelve LNG plants under construction in the world.
Of these twelve, seven are located in Australia. The other five: one in the US, Cheniere Energy (NYSE: LNG) at the Louisiana/Texas Sabine Pass, with the others located in Columbia, Indonesia, Malaysia and New Guinea. Credit should be given to Canberra for allowing energy companies to move forward with these projects. Once all of these plants are on stream, it is possible by 2020 Australia will rival Qatar as the world's largest LNG supplier.
Granted the anticipated revenue stream is quite deferred, but the billions being spent on the construction projects currently is bolstering the economy. Likewise the development of the various natural gas and methane supplies is adding to the Aussie GDP. The most recent GDP was a quarterly increase of 0.8%, beating the previous quarter's 0.6% increase. It is estimated the Y/Y GDP increase will be 2.8%.
Meanwhile exports from Australia in January 2014 were A$ 29,759M. This is an all time monthly export high. Perhaps the importance of China to the Australians is overestimated.
The recent run up in the Australian dollar has been short covering, but often when a market fails to go down it goes higher. Barring a catastrophic global macro event, the Australian dollar (FXA, UUP UDN) acts like it wants to work higher. At the moment we are at the top side of the BBs, so we might be a little overdone. Should we relax a bit and work back to the .9150 area, we wish to try the long side of the AUDUSD. Traders can also consider a long AUDJPY around the 93 handle. Against the USD, our target is 96/97. For the AUDJPY, conquering the 95.50 area may give us a chance of trading close to 100.
As always, manage your money carefully.
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.