Forex Investment and Currency Trading

Commodities have not participated in the recent bout of USD selling. Weakness in the global economy clearly remains the key concern. Moreover, leading indicators of global activity suggest the first quarter of next year is unlikely to see much improvement. This is important from the point of view of the AUD, the best correlation with the A$ during global downturns is commodity prices.

The second factor is weak domestic data through Q1. To date the Australian economy has weathered the global downturn reasonably well. However, virtually all the leading indicators of employment are suggesting rising unemployment through the first half of next year. Business surveys are equally downbeat and while consumer sentiment has bounced in recent months, this won’t be maintained once the unemployment rate starts rising.

There is a risk that we overshoot to the downside but a move below 0.50¢ seems unlikely. The last time the AUD fell below this level was in 2001, which was during the last global downturn. Commodity prices were under pressure, much like they are now, although we would note that the WCFI currently remains around 40% above levels that prevailed in 2001. While further weakness in commodity prices is a real risk, a further 40% fall on top of the 50% that has already occurred seems unlikely.

As move in 2009 H2, look to establish a long AUD TWI position. Global growth is likely to be better through the second half of next year as the various policy initiatives among the major countries begin to take effect (this is likely to be particularly evident for China). The environment for commodity prices is also likely to be more upbeat given the emphasis on infrastructure spending within the various fiscal initiatives announced by a number of countries.

Fair value in this case is based on a very simple model of commodity prices, yield spreads and a risk aversion measure. The first point to note is that AUD/USD currently appears over-valued relative to the simple fair value model. This reinforces the view that AUD/USD will weaken through the first quarter of next year.

Conversely the fair value models suggest that AUD is currently undervalued against EUR and CAD. For AUD/EUR - good to being long from current levels for a number of reasons. The pair has developed a good base around the 0.48¢ level and look to build a long position on dips to this level, with a stop just below 0.47¢. There are a number of factors that are likely to weigh on EUR through 2009. The ECB still has some way to go in terms of interest rates. European banks also have the biggest exposure to emerging markets. AUD/EUR is also likely to push higher during the global reflation trade in the second half of next year.

It is a similar story for AUD/CAD. Both economies will experience a negative terms of trade shock in 2009 the AUD will be better placed from a relative yield perspective. Indeed the current yield differential suggests the pair should be trading closer to the 0.90¢ level at present. Hence you would look to buy dips towards the 0.80¢ level looking for a move back up to this level in the second half of next year. Stop loss would be just below the 0.78¢ level.