I’ve been looking more to the currencies as a bond alternative lately. Artificially low interest rates have skewed the market to where I don’t feel investors are being fairly compensated for a lot of the risks associated with bonds right now.
Recently, I’ve had my eye on the Aussie dollar. The Australian dollar has benefited greatly from over a decade of Chinese expansion by being a major exporter of raw materials to China. With Chinese growth slowing there are rising concerns this will create a major drag on the Australian economy since the mining sector makes up close to 20% of their economy. I agree with the concerns to a degree. It’s the reason we’ve seen the Australian dollar fall from $1.10 USD to $0.99 USD over the last two years (Australia is slowing as China decelerates and the US is slowly improving making 1 Australian dollar cheaper to buy with US dollars). Lately some bold calls have been made that the Aussie dollar is on the verge of a major plunge lower– this is where I differ in opinion.
In the long haul, as the world attempts to lessen the dependence on the US dollar, I think we’ll see the Australian dollar continue to emerge as a quality alternative. It’s an advanced economy with important resources on the doorstep of emerging Asia. Not to mention that no one trusts the Swiss anymore after they succumbed to other nation’s demands that they release the names of clients holding assets outside of their home country.
Most people are confused by currency movements because, like most things in the investment world, academic theory is not the same as reality. The textbooks will say that the country with higher interest rates should see its currency appreciate as investors will move their cash there to earn higher interest. In reality, capital seeking investment far outweighs cash sitting in the bank. Currencies will fluctuate based on global supply/demand fundamentals (not just the two countries in the exchange rate) driven by economic investment opportunity. Basically, a currency will rise and fall with a country’s economy. As an economy heats up, new capital floods into the country seeking investment opportunities which creates demand for that currency. Interest rate changes always lag changes in the economy meaning they rise after an economy (and its currency) has done well.
The interesting thing about currencies is that they are self-serving. Since we are an interconnected, global economy, a falling currency makes that nation’s goods and services cheaper to the rest of the world which raises demand for those goods/services and thus improves the economy and lifts the currency. A rising currency will slow an economy which leads to less demand and a drop in the value of a currency relative to others. So, while the Australian economy has been slowing, the question is how far will the Australian dollar fall before it starts to benefit their economy through higher exports?
I may initiate a position in the Australian dollar ETF (FXA) if we get below 95 cents. Most Australians think 85 to 90 US cents is fair value. It also pays out a little over 2% per year in income distributions given the interest rate differential which is comparable to short-term bonds but without some of the risks that bonds bring – like credit risk.
Australian dollar/US dollar Spot – 7 years
(click on the chart to see a larger image)
Thanks for following!
Nick