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Is the Australian Dollar Priced Right?

The Australian Dollar has been meandering sideways for most of 2011, lacking the energy or sponsorship to break out of the range. This week was no exception with the range versus the USD between 1.0074, and 1.02.  This subdued activity is great for the option writers, but opportunities for forex traders is slim.

The A$ has been a big winner over the past two years, as the commodity boom in Asia has stimulated demand for Australian commodities, especially coal and iron ore.  This demand has enabled the Reserve Bank of Australia to aggressively raise rates, as the world moved out of the recession.  With US two year notes yielding only .70, compared to an Aussie yield of a little better than 5%, this spread has appeal to those involved in the carry trade.  The Japanese two year yield is only .26, like wise a profitable origin for the carry trade funding.

In the futures market, the large traders, probably hedge fund managers have been exceptionally active on the buy side of the A$.  The latest COT report showed the big specs were long 72,624 contracts, and short only 6,931 contracts.  The smaller specs are likewise long the A$ with the total spec long over 83k contracts.  With so many people on one side of the market, a continuous review of market conditions is necessary.  A minor change in perception can make for an interesting move in the market.

Is there any threat of such a change that might cause the specs to re-examine their positions?   Part of the tail wind which helped propel the A$ from .60 to 1.02 over the past several years was the ever increasing interest rates.   The RBA in meeting results released last week, chose to keep their rate unchanged at 4.75, and there is no indication of pending rate hikes in the near future. 

The global commodity boom, caused in part by strong Asian economies has been a mixed blessing for the strong A$.  Yes, imports are cheaper, but it is now a lot harder to sell other Aussie products abroad.  Tourism, although less than 5% of GDP, likewise will be hit hard by the combination of the stronger currency and the rapidly increasing air fares caused by the recent explosion in energy prices.

Mining stocks have been big winners in Australia, and controversy has raged over the level of taxation that should apply to new projects.  This controversy was partially responsible for the defeat of the prior PM Rudd.  A compromise tax bill was thought to have been negotiated by the new PM Gillard, one that which would not halt planned expansion of mining investments in Australia.

The name of the tax was changed from the"resource super profits tax" to the "mineral resource rent tax" and the rate was reduced from 40 to 30%.  The mining companies resumed working on their investment plans, but now the Green Party, whose support PM Julia Gillard needs to remain in power is objecting. 

Market Watch reported on 02 15 that  the leader of the Green Party said:

"The big mining companies will effectively take A$60 billion out of Australian taxpayers’ pockets as they gouge profits out of Australian soil and ship it offshore,” Greens leader Bob Brown said.

“BHP Billiton and Rio Tinto will export billions at the expense of Australians, giving away revenue that could fund services and infrastructure,” Brown said."

So far the split between the Green Party and Labour seems to be under the radar, but I suspect if Bob Brown's view's made some headway it would be unsettling for the Aussie investments and their currency.


Is there a trade here?  It looks to me like this pair is spending too much time churning and moving sideways.  With so many longs we will need continual good news to feed the bull, or we will get a sell off.  A risk here is that the war between the mining companies and the Government resumes, an event that would cause the sell off to get some legs.  Lets watch for important news next week.


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Is the Australian Dollar Priced Right?