Australian Dollar and BHP – cousins not twins

September 27, 2011

FOREX, Global Macro

In the Fairfax press today, Ian Verrender has an article about the currency. If you don’t know anything about the topic at hand it is a well written interesting piece. But it slices too thin and rests on an incorrect premise.

Verrender says that :

Our sharemarket may already have priced in a global recession but global traders are taking an each-way bet when it comes to the Aussie dollar.

I don’t agree here – if we look at the performance of the AUD versus the S&P 500 (assuming we can call that or the Dow the global bellwether) then you see in the Bloomberg chart below that the Australian dollar is doing what it always does riding up with risk and riding down with risk. I’ve overlaid the prices but I wouldn’t say it is out performing:

Verrender then compares the Australian dollar to BHP – obviously he has now assimilated the view that Australia is just a quarry and has nothing else going for or against it. But hey he’s not alone in that view even if the rest of the economy might argue differently. Verrender says:

compare the Aussie against the performance of our biggest company, BHP Billiton, the quintessential link between Australian resources and the booming market in China.

Back in May, BHP shares were on fire, marching towards $50.

They closed yesterday at $33.95, a 30 per cent decline in just a few months, as metal prices continued to take a hammering.

The dollar, however, has dropped by only about half that amount during the same period, clearly lagging the sharemarket declines.

That’s a significant break with tradition. In the past, any clouds on the global horizon have caused an avalanche of selling on local currency markets because the Aussie was seen as a risk play. In boom times, the strategy was to buy Australian dollars. But at the first whiff of trouble, dump it.

I think I’ve made my point about the Australian dollar and equities with the S&P 500 chart above but let’s look at BHP as an indicator, on its own, for the AUD in the following two charts:

Green is BHP, white is the Australian dollar and orange is the S&P 500, indexed to 100 at the start of 2003. You can see that BHP has outpointed and outstripped both the currency and the overall global bellwether stockmarket. No arguments there, it should do so as a pure commodity exposed equity play, but this is important in understanding why perhaps the give back of BHP, when it comes, is bigger than the give back in the Australian dollar. Moreover, as you can see from the chart in 2008, it’s a long bow to draw to suggest BHP is now priced for global recession.

If I overlay the BHP, Australian Dollar and S&P 500 charts instead of indexing them to 100 we can see that directionally BHP is a good fit, but only good – PART of the model, not THE model. It’s an input into the 5 drivers that determine the Australian dollar’s value, but one level below:

The Australian dollar is more than just a quarry, or BHP, or equities, or risk assets or interest rates or investor sentiment. It is all of this and more. It is the amalgam of these indicators and the process followed over the time frame being assessed that will determine where the Australian dollar is going not just where the Big Australian is headed.

Cross posted with www.macrobusiness.com.au

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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