In this article, I am going to explain an interesting phenomenon that is happening in the forex market right now in the first week of 2015. For those of you who read my weekly economic calendar article on the AUD, titled 'Focus On Very Important AUD Economic Calendar Events - 1st Week Of 2015', you might have a glimpse of the answer. This article is also inspired by one of the readers who asked 'Looking forward to this series. Why are you long term bearish on AUD?'
This article will be a full length article that answers this question and points out the short term bullishness of the AUD. By short term, I refer to a period of between 1 to 3 weeks. Timing is important in trading because even if you are right to short the AUD in the long term, you might lose your nerve and reverse your position just after the short term bullish retracement is over and lose double the money. Of course, a suitable position size is important and this is used to limit your risk or possible losses. However I would not give my opinion on the entry price, stop loss and profit. That you will have to decide for yourself and these parameters would also depend on the time when you read this article. Of course, this is just my opinion and there is no absolute in the market so use it with discretion.
Over the long term, it is imperative to look at the fundamental picture of the Australian Dollar (AUD) to determine our bias for the strength of the currency. We are going to take a look at the Gross Domestic Product (GDP), Balance of Trade and the Unemployment Rate to determine the fundamental outlook for Australia.
In terms of GDP, there are 2 ways we can look at it, we can look at the growth over the previous quarter or we can look at the growth over the same quarter last year. We will look at both methods of looking at GDP growth and we can see that growth has slowed down.
The annual growth rate cancels out the seasonal effects of each quarter and shows the growth rate over each preceding year. We can see that while 2014 is slightly better than 2013 in terms of growth, it is not breaking out and it is not reaching the 2012 rate of growth.
The quarter on quarter growth shows the rate of growth over time more sensitively and we can see that it has dropped to 0.3% this quarter for Australia compared to the second quarter. This is the lowest in 3 years and this is a major source of concern even if it is growing at 2.7% on an annualized basis. In the third quarter of 2013, we are seeing a quarter on quarter growth of 0.6% after a 0.7% second quarter growth. This shows that if Australia's economy has a healthy growth, it should be growing stronger quarterly instead of 0.3%. We can take reference from the 5% quarterly GDP growth in the US.
The Australian economy is dominated by the service sector which accounts for 65% of GDP but it is the mining sector which takes up 13.5% of GDP which comes to mind first when investors talk about Australia. Australia is seen as the supplier of real materials such as metal, coal, oil and gas to China to support its infrastructure growth. During 2008 to 2009, China's demand for these commodities shielded Australia from the worst of the Great Recession. During 2010 to 2011, commodities prices remain high and Australia reported consistent balance of trade surplus.
However, in the past 7 months, we see that Australia has reported deficits as they imported a lot more than they exported. This would mean that they will have to sell the AUD to purchase their goods and services on a net basis. This drop in export can be attributed to China's reduced reliance of Australia's import as it prepares itself for a period of slower growth. For the position of currency strength, as Australia sells its currency to support its net import, this is bearish on the AUD.
On a slightly more positive note for Australia, the deficit has been reduced as exports rose slightly by 2% and import fell by 2% in seasonally adjusted terms. Australia reduced its imports of capital, merchandise and consumption goods in October while it increased its export of non rural goods and services. While this is a start, we are not sure if Australia can sustain the narrowing of its deficit but given the previous 7 months of deficit and the slowdown in China, we are not giving Australia the benefit of the doubt. It is likely that the October's deficit narrowing is just a flash in the pan.
Lastly we look at the unemployment data to have a better sense of the recovery. The November 2014 unemployment rate rose from 6.2% in October to 6.3%. We saw that the participation rate remained stable at 64.7% and while the number of people employed increased, we also saw the number of unemployed people increased slightly to push up the unemployment rate.
This chart shows us that the unemployment rate has increased steadily since April 2014 as Australian employers shed jobs. This indicates that Australian employers see lesser demand for the goods and services and implied a gloomier economic outlook.
Hence having discussed the GDP growth, balance of trade deficit and the unemployment, I have covered the reasons why I am long term bearish on the AUD. However to look into the reason behind my short term bullishness for the AUD, we have to look at the candlestick chart of the AUD. In short, I am going to make the argument that the market has consistently and diligently priced in the weakness of the Australian economy. Even though it is unlikely to post strong growth in the future, the market is going to take a breather and take profits before resuming its downtrend. Hence there is an opportunity to go long the AUD in this limited period of time. Of course, we wouldn't know for sure how long this bullish retracement of the AUD will be but at least we will know not to short the AUD until the retracement is done.
We can use the CurrencyShares Australian Dollar Trust ETF (NYSEARCA:FXA) chart below to gauge the strength of the AUD. The FXA tracks the performance of the AUD net of expenses of 0.41% and it is listed on the New York Stock Exchange in United States Dollars.
You may have seen this chart before but it is worth repeating as it shows 3 technical indicators as seen above that are all aligned to point to a temporary bullishness in the AUD. This is quite rare in the forex world. Normally we will have 2 signals pointing up and 1 signal pointing down and it is up to you to decide how you want to trade it. This type of technical consistency is as far as a sure trade that you will get in forex but again we would not know for sure how long this will last. However the earlier you can enter into the trade, the lesser chance it has been played out in the market.
Another way we can look into this is from the spot currency market of the AUD/USD. As we know that the USD is the strongest currency around these days with the strongest recovery of 5% GDP growth among the major economy.
The weekly chart gives us a better long term perspective of the AUD. We can see that its decline has been steep since September after spending April to August in a range. Of course this is after it had a mini rally from January to March 2014 and whether you believe it or not, you can match this to the 3.5% annual GDP growth in the first quarter of 2014 followed by 2.7% GDP growth for the second and third quarters. The point to note is that these GDP reports come in approximately 2 months after the end of that quarter while these prices are in real time.
What this weekly chart also tells us is that the AUD/USD had previously spent 5 consecutive weeks of steep decline before it retraced for 4 weeks. This retracement was to the .382 Fibonacci level and this is not shown as it is too messy to present all in one chart. Now we see that the AUD/USD has dropped for 7 consecutive weeks and it is time for its retracement. So we have 2 separate technical charts from different sources showing a short term bullishness of the AUD.
Finally we have the daily chart which shows us how far the retracement can possibly go before the downtrend resumes. You can take this as reference point. It is not going to 100% accurate as when more people participate, the price levels get taken out faster. The .236 and .382 levels are approximately 0.8252 and 0.8356 and we can expect a retracement to occur at either of these 2 levels.
Hence I think readers will have a better idea why I am bearish on the AUD in the long term but bullish on the AUD in the short term together with a better fundamental understanding of the AUD. Good luck trading in these thin markets and as with all trading, there are risks and rewards. This may be a simple statement but I still find it refreshing as we can be overoptimistic when our positions go with us and overpessimistic when the our positions go against us. A good trader will have the psychological self-control and the self control in position size to live and trade another day if the trader is wrong.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author is long the AUDUSD.