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Predicting short-term currency moves or buying stocks solely on the basis of currency expectations is dangerous. There are better ways to profit from a lower Australian dollar.
This week’s equities sell off put currencies front and centre for investors. The US/China trade war escalated after President Trump placed a 10% tariff on another US$300 billion of Chinese goods, and China let the Yuan drop to an 11-year low against the Greenback.
Our share market is down almost 5% from its recent high as this column is written and the Australian currency is US67.17 cents. Our dollar hit a 10-year low this week after New Zealand’s central bank surprisingly cut interest rates. Investors fear the worsening trade dispute will cause a recession in parts of Asia and crimp global economic growth.
Trying to second-guess Trump’s next trade-war tweet and how it will rattle global financial markets is pointless. Hopefully, the market damage this week is enough to encourage the superpowers to pause trade hostilities. That seems unlikely.
My base case for the past three years has been for a gradually easing Australian dollar against the Greenback. I first outlined that view for the Switzer Report in September 2016 in “Cashing in on a weaker Australian dollar”. Our dollar then was US75 cents and after some brief gains in 2017 has tracked lower.
Expectations of lower Australian interest rates and higher US interest rates underpinned my view. I was half correct: our official cash rate has fallen further than most economists expected. But US interest rates were recently cut, when markets previously had expected an increase.
I expect the Reserve Bank to cut again in September or October, partly as insurance against the fallout from the trade war, and again in February 2020. Although an interest-rate low of 50 basis points is reasonable, don’t be surprised if rates head towards zero and beyond in 2020.
About US$15 trillion in sovereign bonds is receiving a negative yield and more European countries have joined Japan in the negative interest-rate club. Macquarie Wealth Management this week wrote that “rates must go negative everywhere” until government policies change.
Sadly, it is a global race to the bottom in interest rates. What matters most is how much further the US Federal Reserve cuts its rate. The Fed confused markets after this month’s cut, suggesting it may be a one-off for now. I expect the Fed to keep cutting rates.
That said, I don’t expect US rate cuts to be as aggressive as those in Australia – our economy is in worse shape and needs more stimulus. So, the interest-rate differential between Australia and the US favours a slightly lower Australian dollar over the next few months.
Commodities also add to the case for an easing Australian dollar. Rising iron ore, thermal coal and other metals are good for a commodity-based currency such as ours. But the trade war has to hurt Asian growth and global growth generally – that’s bad for commodity demand and prices. A larger-than-expected slowdown in Chinese growth would thump commodity prices.
Lower rates and lower commodity prices should drive our dollar to US65 cents by year-end, possibly towards US60 cents if the trade war escalates further.
As AMP’s Shane Oliver notes, excessive Australian-dollar short positions, high iron-ore prices and the US Fed cutting rates will provide “some support through occasional bounces” and prevent an Australian-dollar crash.
In other words, expect a gradual easing in the Australian dollar against the Greenback over the next 12 months rather than an abrupt fall.
A fall of a few cents in our currency over six months to a year does not seem much. But in an environment of record low rates, every extra point of return counts. A 5% or more fall in our currency could make a big difference to returns, all other things being equal.
1. Stocks with offshore earnings exposure
A favoured strategy is buying Australian companies with a high proportion of offshore earnings that are worth more when translated to our currency. Or buying large exporters, such as miners.
Usual suspects include Macquarie Group, Computershare, James Hardie Industries, Aristocrat, Cochlear, CSL, News Corp, ResMed, Amcor, Treasury Wine Estates, Ansell and Incitec Pivot. Austal and IDP Education are impressive small-caps with offshore earnings.
Among blue chips, Macquarie Group stands out. The investment bank earns around 60 per cent of revenue outside Australia. About 29 per cent of total revenue is made in the US, Morningstar data shows.
Macquarie’s strong position in infrastructure and property is valuable. Nevertheless, investors will mark it down as deteriorating market conditions affect its investment-banking operations.
Falls in Macquarie’s share price during the market sell-off would be a buying opportunity. Morningstar values the stock at $135, implying a sufficient margin of safety to the current $119.
Outside of Macquarie, I’m wary of buying stocks based solely on currency exposures. The large-caps earn revenue in different markets and are exposed to various currencies for their revenues and costs. Also, miners benefit from a lower dollar, but slowing global economic growth can hurt commodity demand and prices, meaning currency gains are complex.
Equity-market correlation is another factor. Australian companies that benefit from a lower currency can still get thumped when equity markets falls. If you want exposure to a falling Australian dollar there are cleaner ways to do it than through large-cap equities.
Chart 1: Macquarie Group (MQG:ASX) one-year price performance
Investors can use gold to play a lower Australian dollar in a few ways. First, buying Australian gold equities that benefit from a rallying Australian-dollar gold price. Second, buying Australian-dollar gold through an Exchange Traded Fund (ETF), unhedged for currency exposure.
Or third, benefiting from gold’s safe-haven qualities during heightened market volatility. As more countries join the negative interest-rate club, and investors lose confidence in the value of fiat money, gold’s status as a store of value comes to the fore.
I have been bullish on gold this year and preferred exposure to gold bullion than to gold equities. I wish I’d been more bullish on gold equities – several have soared this year – but exposure to gold bullion eliminates company and market risk.
The ETFS Physical Gold ETF (ASX Code: GOLD) is the market’s largest gold ETF. I nominated it for the Switzer Report in November 2018 at $161, partly because it benefits from a lower Australian dollar. The ETF has rallied to $208 – a 29% gain in nine months.
Gains will be slower from here, but there’s a lot to like about Australian-dollar gold in the next 12 months as market volatility remains elevated and our currency gradually eases.
Chart 2: ETFS Physical Gold ETF (GOLD:ASX) one-year price performance
3. Currency ETFs
A convenient, cheap way to gain exposure to a falling Australian dollar is via an ASX-quoted currency ETF. Unlike buying equities or gold, you are gaining pure exposure to currency.
The BetaShares US dollar ETF (USD) is my preferred tool. It is designed to rise if the US dollar rises against the Australian dollar (our dollar falls in value), and vice versa. The ETF has returned almost 10 per cent this year as our dollar has eased against the Greenback.
Investors who want greater exposure could use BetaShares Strong US Dollar Fund (YANK), which increases exposure to rises or falls in our currency by 2 to 2.75 times.
I am not a fan of leveraged ETFs that magnify gains and losses, so prefer the USD ETF. Don’t expect earth-shattering returns from USD; if our currency continues to edge lower against the Greenback in the next 12 months, a 5-10% gain in USD is possible.
In a low-rate climate, that returns looks relatively more attractive by the day.
Chart 3: BetaShares US Dollar ETF