The Aussie Dollar Races to Parity

Includes: BHP, FAX, FXA
by: Investment U

By Tony D’Altorio

Most Australians spent November 2nd enjoying the annual Melbourne Cup, the country’s biggest horse race. Not Glenn Stevens, governor of the Reserve Bank of Australia (RBA), though. Instead, he surprised the markets by raising interest rates a quarter percent to 4.75%.

Under his guidance, the RBA has raised interest rates seven times since Australian interest rates hit a record low of 3% last October. The only developed nation to avoid recession after the financial crisis, it has aggressively raised rates since.

Thanks to this latest move, the Australian dollar – or Aussie – now equals its U.S. rival. Since it began floating freely in 1983, that has never happened before. Meanwhile, in the U.S., Ben Bernanke keeps interest rates near zero. And under his guidance, the Federal Reserve continues to print copious amounts of money. It’s no wonder that the Aussie has risen 11% against the US dollar this year.

The Australian Dollar Stands Out from the Crowd…

With countries everywhere trying to suppress their currencies, Australia stands out. Unlike most other central banks, it isn’t complaining about the Aussie dollar’s strength. Instead, it believes its rising currency will help control inflation.

Lee Hardman, at Bank of Tokyo-Mitsubishi UFJ says, “Australia appears to be one of the only countries… not overly concerned by domestic currency appreciation.”

He believes widening differentials between Australian interest rates and those of other nations has fueled the Aussie’s strength. And he points out that the sharp rebound in global commodity prices – thanks to robust Asian demand – has also boosted it.

RBA figures definitely back Hardman up, showing Australia’s export-import ratio at its highest level since the 1950s. That has almost doubled over the past decade, while the country’s persistent current account deficit all but vanished last quarter.

According to Divyang Shah at IFR Markets, the Aussie’s fair value lies much higher than its U.S. counterpart. “The terms of trade [exports over imports] suggest the Australian dollar is still significantly undervalued.”

Investors Are Desperate For Hard Assets Like the Aussie

With QE2 on the way, investors desperately want hard assets, like the Aussie, to invest. Shah also notes how central banks and sovereign wealth funds need to protect against the dollar’s weakness; he expects them to be the Australian dollar’s biggest buyers.

Analysts like Societe Generale’s Kit Juckes agree. He predicts the Aussie rising to $1.05. Bears, however, point to the large long positions investors already have in the currency. The Australian dollar against the U.S. dollar is the fourth most actively traded pair.

Then again, these same people usually don’t think much of Asia either. They think the Aussie’s strength comes merely from a build-up of unsustainable global imbalances. In short, they don’t expect Asia’s strong economic growth to last very long. But keep in mind that they’ve been singing the same tune for years now… without much luck so far.

Aussie Income Investments

Admittedly, the bears are right about one thing: Australia does have a seemingly endless amount of dirt and rock that Asia can’t get enough of. But if the Asian middle class continues to rise as a long-term trend, then so will the Aussie.

As it does, Australia’s biggest dirt and rock digger, BHP Billiton (NYSE: BHP) profits. Its stock has already risen over a quarter this year, not to mention its current 2.13 yield. And conservative investors who look for income over capital gains also have a way in:

  • Rydex CurrencyShares Australian Dollar Trust (NYSE: FXA) holds only Australian dollars. Up 14.25% year-to-date, it pays a monthly dividend. In September, that amounted to $0.2939, and $0.30051 in October.
  • Aberdeen Asia-Pacific Income Fund (NYSE: FAX) is a closed end fund. Returning nearly 20% over the past year, it pays out a monthly distribution as well, currently set at 3.5 cents. It mainly invests in Asian bonds with an average maturity of 7%. And as of the last quarter, it had 43% exposure to the Australian dollar and Australian bonds.

Additionally, at 4.75%, FAX is trading at a discount to its net asset value. So investors can buy the shares for less than its portfolio’s actual worth. Unlike the U.S. dollar, it still has something to talk about.

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