Tuesday 21 October 2014 by Opinion

Australian dollar heading for 68-75c versus the US dollar?

Over the past month we have written a series of articles on strategies to protect your overall investment portfolio and how to profit from a falling Australian dollar (AUD); in this instalment we ponder that if history is any indicator, the AUD could be heading for 68-75 cents against the increasingly strong US Dollar and discuss three strategies to profit from such a move.

If history is any indicator, the AUD could be heading for 68-75 cents against the increasingly strong US Dollar (USD). To view the following articles: "High yield USD portfolio earning 7.2%" please click here and "Australian Dollar doldrums - how to use bonds to profit from a falling Aussie dollar and earn 3-4% p.a." click here.

Our analysis of the performance of the USD against its major trading partners’ currencies shows a clear pattern: there have been three periods in which the US economy has led the world economy out of an economic slowdown: 1983-85; 1991-93; and 1998-01, as shown in the blue bars below.

Each of those periods has marked the start of a bull run for the USD, as you would expect. Less intuitive is the fact that the USD has risen each time far more against the AUD than its other partners. These periods have seen the AUD fall an average of 35%. From its recent peaks, that would result in an AUD/USD exchange rate of 71 cents.

usd performance and relationship to economic strength
Should you believe that history is repeating itself and this is the start of a prolonged period of AUD weakness, there are three strategies for profiting from this scenario:

1: Invest in the USD

The simplest way to profit is to be “long USD”, that is have a direct exposure to US Dollars. You can do this through a US bank account (very low interest); US shares unhedged (subject to rule 3 below); or USD denominated corporate bonds. The latter strategy has been one our clients have been successfully using for some time with yields of 2-10% p.a. on top of the 8.3% rise in the USD in the last 12 months. This is also a strong hedge against the likelihood of falling equity returns when the global economy is slow. The table at the end of the article highlights some of the most commonly traded USD bonds by our clients.

2: Invest in Australian corporates with an exposure to export earnings

Some companies will do well in a falling AUD environment, despite the slower economy. Sydney Airport for example benefits from increased tourism traffic, and to a lesser extent Perth or Brisbane Airports. Universities such as ANU may benefit from an increase in high fee paying international students. Similarly, exporters such as Mackay Sugar, Newcrest and Fortescue will also benefit from a lower AUD.

3: Reduce holdings in high risk assets or those with high growth multiples

Equities need earnings growth to perform, particularly when trading at high price-earnings ratios. Low economic growth therefore typically means low equities performance. Avoid overpriced equities as earnings are likely to disappoint in such environments.

History can be a poor guide of the future, but a repeat of this historic pattern is intuitive. Today we face a slow recovery globally, one driven by the relative strong US economy. The IMF, World Bank, OECD and most of the G20 central banks are forecasting the US economy to be growing faster than the G20 average for the next 2-3 years at least. The EU is struggling to keep out of recession for the third time in five years, with the critical German powerhouse stalling and Japan’s recovery threatened by the second round of its new consumption tax starting in 12 months.

Commonly traded USD bonds as referred to in strategy 1 above include:

USD bonds

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities. All USD bonds mentioned in this article are available to wholesale investors only. This article should not be read as an AUD/USD currency forecast and investors should form their own view on the direction of the AUD/USD exchange rate.