Copper's optimism through its exuberant rally of the last two months of 2016 was not shared by the Aussie dollar. This created a gap that needed to be bridged. Either the excessive speculation on copper's price (NYSEARCA:JJC) would have to be corrected or the underperforming Australian currency (NYSEARCA:FXA) would need to realign with global reflationary dynamics. Indeed, the two assets started to come closer together, as some of the ultra-bull traders stepped out of copper, and Aussie ultimately found some fundamentally driven buying support. The synthetic trade consisting of a short position on copper paired with an equally weighted long position on AUDUSD started to bear the first fruits. In fact, the copper side of this synthetic trade was the one which brought the first profits, while the Aussie, which initially sold-off, rebounded in the last few days in anticipation of some positive macro developments. Some big surprises out of the Australian trade balance situation started to revive the interest in the Aussie dollar, exactly at a time that copper trading activity started to normalize in terms of volatility. Under this light, the gap between copper and the Aussie seems more likely to be closing with the upwards adjustment of the latter, further down the road.
Recently China announced a half a trillion dollars infrastructure spending plan in order to modernize its rail network. With Australia's commodities sector having very close ties to China, the long Aussie position of the trade is most certainly the one to benefit the most out of this development. This means that the initial synthetic trade could be modified by taking profits in the short copper position, and by leaving the long Aussie position to unleash its true dynamic. It's time for the real economy to do its magic and for traders to push the Aussie towards its deserved position! This position will come as a result of the shifting dynamics of the Australian economy itself, which seems to have finally begun getting what it was looking for; a solid foreign demand for its natural resources.
Aussie Gets New Bullish Factors On Its Side
The first evidence of a major turning point of the Australia's came with the surprisingly positive latest release of its international trade statistics. The November trade balance recorded the first surplus since Q1 2014, in a highly unanticipated development. Also, the October trade deficit was revised significantly lower to A$1.1 billion from an initial estimate of A$1.54 billion, signaling less pessimistic conditions than what markets have initially feared about. As we have discussed, a positive turnaround of the Australian trade balance could be the trigger for a new bullish phase in AUD; and it seems that the time has come.
As a matter of fact, turnaround cycles of the Australian trade balance in the past were accompanied by strong bullish moves of its currency. During 2010, for example, the achievement of persistent trade surpluses for the first time since the Great Financial Crisis fueled a strong bullish trend in AUDUSD which drove the Aussie to $1.1 after having plummeted to as low as 60 cents during the GFC. When the Aussie lost its trade surplus support in 2012, the big bearish AUD market began, which led the currency to the 2016 low of 68 cents. The soft landing and rebalancing process of China and the rest of EM Asia Pacific, as well as the entrapment of the advanced economies in a sub-par growth environment were responsible for this long-lasting Aussie bear market.
Currently, though, the regional as well as global macro backdrop seems to be shifting in favor of the Aussie dollar, after this long and painful period of adjustment. A closer look at Australia's trade figures will reveal not only the turnaround in the trade balance but the competitive position of the Aussie in general. Australian exports have marked their highest value ever in November, outperforming the rest of Asia Pacific's top exporters. In particular, New Zealand's exports have been trending steadily downwards since 2014, as China's, Japan's, and South Korea's have. These bearish trends come in contrast to Australia's bullish export patterns.
This positive divergence of Australia's trade dynamics coupled with the positioning of the Aussie's real trade weighted index to the lower portion of its last six years trading range, leads us to the conclusion that the Australian currency has become highly competitive again.
This competitive positioning of the Aussie meets the global reflationary scenario at its infancy, and this mix could not be more sanguine for the Australian currency. A growing number or pro-growth signals occurs at a time that an increasingly global coordination of fiscal expansionary policies from the US to China attempts to mark an new era; the effort of policy makers to empower the global business cycle with the multiplying effect of fiscal stimuli and the gradual normalization of ultra-accommodative monetary policies, in the US and hopefully in the rest of the world. This policy mix could not be more bullish for pro-growth currencies like the Aussie dollar, granted that its design and execution will be carefully done.
The signals are already here, spanning from repetitive positive surprises of market expectations about key macroeconomic indicators across the globe, to sustained bull markets in shipping freight cost indices, commodities, and long-term bond yields.
Having said these, the initial synthetic trade consisting of a short position on copper coupled with a long position on AUDUSD can now be modified. Copper seems to have corrected some of its excessive trading activity, bringing its short-term volatility to more normalized levels, and inducing traders to pair some of their excessive net long futures positions on this basic metal. The short-term gains from the short position on copper are better to be taken off the table and allow the long Aussie position to take advantage of the unfolding reflationary scenario, strategically aimed by its increased competitiveness against its rival currencies.
The balance between excessive speculation and the real economy, which was at the heart of the spread trade between copper and the Aussie dollar, seems to be leaning towards the latter. Having the avid commodity speculators taken out of the equation, the gap between copper's optimism and Aussie's pessimism will most certainly be bridged with an AUD rise. In this light, how far can be the Aussie expected to run? AUDUSD bounced off its medium-term support level of 71.5 cents, paving the ground for a gradual rise towards the resistance of 78 cents. This creates a nice reward/risk profile for the long Aussie trade, since the exchange rate currently hovers around the lower part of its sizable trading zone of the last nine months or so. Any credible attempt by the market to break below the lower bound of this zone should be regarded as a signal to unwind this position. On the opposite side, any attempt of the AUDUSD to break this zone to the upside, beyond the initial target of 78 cents will definitely need more solid reflationary evidence at hand.
The Aussie dollar is a traditionally pro-growth currency closely linked to regional as well as global trade conditions. After a long painful period of global macro adjustment, a potentially new beneficial cycle is about to begin. Should that happen, the Aussie dollar will benefit overwhelmingly against its currency peers, as well as against commodity markets such as copper. Will Aussie turn into an outperformer again? Nothing is for sure, but one thing is certain; some of the greatest dislocations in markets lie in the lagging behavior of the Australian currency. This alone deserves to give it a try.
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The views expressed in this article are solely those of the author, provided for informative purposes only and in no case constitute investment advice.