Tuesday, June 29, 2004 THE next few years could see an alignment as rare as the recent transit of Venus; an extended period of Australian dollar weakness combined with strong commodity prices. But unlike Venus' six-hour trek across the face of the Sun, the combination of weak dollar and high metal prices could last for many years. By Peter Gibson
This week I examine the currency. Next week I will discuss the positive outlook for commodity prices and draw the two strands together.
From early 2002 to early 2004 the Aussie dollar appreciated by roughly 60% against the US dollar.
The Australian dollar was certainly undervalued to begin with, but by itself that is not enough to spark a rally.
The rise was caused by a number of clearly defined factors. In order of importance these were: the US dollar was experiencing a structural decline; the strong growth of the Asian economies (which take 60% of our exports) provided a positive terms of trade shock, and; Australia's bond market was offering some of highest relative yields on offer.
Any one of these three factors would have given our currency a lift. In combination they made the Aussie dollar one of the best performers of the last two years. But all of these factors are now reversing, so our dollar should therefore be entering a period of under-performance against the US currency.
Today, the US dollar has regained some of its verve as economic growth takes hold and investors unwind the profitable carry trades funded by selling low-yield US dollars and buying higher yielding foreign assets.
The US dollar's decline has ceased, and despite protestations from gold bugs, it is more likely to enter an uptrend than to resume its downtrend as economic vitality returns to the world's largest economy.
As I have discussed in previous columns, the large US budget and trade deficits are unlikely to hurt the US dollar while global investors believe in the underlying vitality of the US economy.
US growth is now rising strongly – most importantly, it is rising more strongly than Europe – so the dollar is virtually a one-way bet.
The Chinese economic slowdown has started. Whether this is a hard landing or a soft landing is the trillion-dollar question.
Bulls like to point that that China has successfully engineered three soft landings in the last 15 years, all of them from much weaker starting positions than the current situation.
Bears bemoan the immaturity of China's financial sector and the weakness of its price signals.
These 'faults' are precisely the reason the slowdown will be mild. Ordinary Chinese will find it much easier to deal with the withdrawal of easy credit if they aren't exposed to the exaggerated market signals we in the West must face during an economic slowdown.
Any pause in the Chinese economy will hurt commodity prices and volumes, although a mild downturn may have little real impact as the growing US economy will pick-up much of the slack.
There is no reason to believe metal prices will collapse, indeed some commentators believe we have already seen the worst of the correction.
The US economy will slow from its recent high rate of growth, but the changing composition of that growth (more capital equipment and fixed asset investment as the cycle matures) is likely to favour metal demand.
As an aside, the gradual withdrawal of monetary stimulus is already priced into the US bond market, so it seems a bit pointless worrying about the effect of rising US interest rates.
The reality of higher short rates will be shrugged off very quickly as the market has already repriced bonds in anticipation of the rise.
The irrelevance of the rate rise announcements won't stop newspaper economists making a song and dance about them.
Finally, the RBA is ahead of the global tightening curve so the relative attractiveness of high rates in Australia will decline as investors move funds into other countries that still have some way to tighten.
The recent softness in the property market even suggests economists may soon start talking about the possibility of a cut in Australian rates. That would be a strong sell signal for the global hot-money managers.
The reversal of the factors that drove the currency up in 2002 and 2003 suggests the Australian dollar could continue to weaken this year and next.
I believe the dollar could trade down to 61-63c by early 2005.
The move could be even quicker if there is a change of government at the forthcoming election.
ASX Price at posting:
0.0¢ Sentiment: None Disclosure: Not Held
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