USD is close to Yen resistance at Y105

The USD-JPY has reached an important resistance level and appears destined for a sell-down. The USD has rallied to Y105, but it has yet to break out of its downtrend. The prospect of a higher US interest rates would be a possible reason for this to occur, however I dont see higher Fed rates just yet.
Still looking for the USD to fall to Y85.
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Andrew Sheldon www.sheldonthinks.com

USD-JPY still Y85-bound

The chart attached shows the USD staging something of a recovery against the JPY. I see this as a short term recovery. So short term in fact that I think as we go into today's trading I am expecting the USD will be sold off. Why? Because the USD has retraced to the previous resistance level it breached. The next major support is Y85. It will go to that level because the market knows that in an election year the US government & Federal Reserve will be pulling out all stops to win the next election. It wont happen. Americans are waking up to themselves, and their cholesterol-free, low-sugar diets, and will have a reality check. So we are looking at a further 15% fall in the USD-JPY, which on top of a 8% rise in the EUR-USD, suggests we should be looking at a 7% strengthening in the EUR-JPY over the corresponding period, just as an arbitrary.
So watch tonight as the USD is sold off, and that will set the scene for next week. Strong gold week.

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Andrew Sheldon www.sheldonthinks.com

EUR-USD heading for USD1.70

Looking at the chart its apparent that the EUR-USD is going to USD1.70, at which point it will do a double bottom. I would then expect it to return back to its normal trading trade. The technical reasons for this are the strong symmetry evident in the chart. The USD has a 'parityband' between USD1.20-1.35 and has traded within 35c of that band. I am sure the market will be looking to retain that symmetry. So the EUR-USD will be a good 'short' trade from 1.70, though based on prior history, we can expect a 'double top', just as it previously made a 'double bottom' in 2001-2.
In terms of fundamentals, I would expect the Eurozone to welcome the strong EUR as a way of stimulating or supporting US exports in the short term. They might even appreciate the 'lost competitiveness' as a means of driving economic reforms in the EU. The time period is quite long, but we can expect the US election to have reached a result by the time we see the 'double top', then we can expect a recovery in the USD, initially motivated by expectations of rising interest rates in the US, but later also the prospect of greater taxes on the rich. I also believe the US under Obama will adopt a tax on energy, and likely that will subsidise health and alternative energy programs.

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Andrew Sheldon www.sheldonthinks.com

AUD-USD set to break resistance at 95c

Looking at the AUD-USD its readily apparent that the AUD is not about to fall back as many pundits are suggesting. In fact I would suggest its building momentum for an assault on 'parity' with the USD. Clearly breaking resistance at 95c is the next hurdle.
I have already suggested my reasons why. The only reason for thinking this would change is one factor only - the strong inflation numbers. But I dare say that will fall back as money supply growth is curtailed.

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Andrew Sheldon www.sheldonthinks.com

The AUD and its widening trade deficit

I maintain that the AUD will remain strong and that the widening trade deficit is symptomatic of a strong economy. A widening deficit is a basis for higher interest rates, whilst job losses in the USA are justification (a rationalisation) for lower rates in the USA. Regardless mortgage rates will not stay low in the USA beyond 2008. The subsidisation of the bank's short term loan requirements is an electino strategy more than an attempt to secure the banking sector.
The AUD will do better than CAD, which produces a significant amount of oil, but it lacks the significant contribution that coal and iron ore make to the Australian economy. It is also exposed to the malaise in the USA economy. The notion that the RBA would cut interest rates to maintain growth is nonsense because it ignores rising inflationary pressures in Australia.

Source:http://business.smh.com.au/dollar-off-highs-after-trade-deficit-widens/20080407-2462.html?sssdmh=dm16.309681
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Andrew Sheldon www.sheldonthinks.com

The outlook for the AUD

Contrary to the belief that the AUD will weaken because of softer global economic activity, I believe the AUD remain strong against the USD, and to a lesser extent against the JPY. By that I mean I expect the AUD to reach parity with the USD and for the AUD to eventually break Y90. I don’t rate the high personal debt levels in Australia or NZ as a significant obstacle, though they are certain to cause some domestic hardship for some borrowers and lenders.

The high debt level is actually a benefit. The market wants yield, and is not looking for any significant global growth, notwithstanding the opportunities to short term trade . High interest rates in environment of high debt means reduced consumption, particularly of imports. High mineral prices because of capacity constraints mean high export revenues. Paradoxically Aust is benefiting from strong prices because of its 'poor planning'. This is requiring huge capital investment in Australia, so personal consumption is weak, but investment in productive capacity is buoyant and will remain so. We might event expect the government to kick in with some public works (particularly transport infrastructure) once signs of softening emerge. Also expect strong Chinese direct investment in Australian mineral projects funded by China surpluses and motivated by the desire secure mineral supplies. Aust is a net exporter of hydrocarbons (because of LNG), so high oil prices only reduce domestic consumption, which is another plus. The Australian RBA needs to worry about inflation so I don’t see any softness on interest rate policy. Only downside is a few foreclosures but I don’t see a great problem since job losses will be minimal. I cant imagine a better looking economy.

When the food sector recovers from drought after rains last in 2007, we can look forward to stronger export earnings from the farm sector. That will be another strength, destined to drive the AUD to USD parity....but not yet. Consolidation first in the 80-90 range to USD.

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Andrew Sheldon www.sheldonthinks.com

The end of the carry trade

I see no sign that the carry trade will end soon, in fact I think its as strong as ever. The critical issues are:
1. Japan's growth prospects depend on local deregulation and/or immigration
2. Japan's interest rates are linked to its mercantilist trade policies - that will not die until the USA makes it an issue. It might well be a concerted effort by EU/USA that makes the difference given the recent strength of the Euro.

Based on the fact that there is no sign of change on these fronts, we can expect:
1. Japan to continue its mercantilist policy - Japanese interest rates to remain low
2. Japan to retain its subdued levels of economic growth

As long as Japan has interest rates at 0.5%-2%, we will continue to see carry trades. But the carry trade is not a single trade, rather a series of trades, in & out based on the performance of the respective currencies. It cannot be considered to be purely a AUD play, anymore than it canIf not in Australia then other countries. So buying JPY/AUD may only hurt if Australia does be considered a CAD$ or RSA play. Its all a matter of respective merit. You can be sure however that the AUD and NZD will feature highly because of their merits and high yields.

I see little possibility of the AUD being displaced by other currencies as a better 'carry'. There are not many candidates for the very reason that makes the AUD such a great trade. These are commodity exposure (RSA, Canada dont match), relatively free market, periodically big spenders (terms of trade implications), best China/India exposure (terms of trade implications), and commodity exposure (best worldwide).
I dont see Australia loosing this status because of China/India. I cant see Asia gaining it because they will be big savers for a long time, and they are prone to subsidise interest rates. I would suggest more likely you will see Japan end the carry trade. At some point Japan & China will be forced to drop the mercantilist trade policy they learned from Britain. I dare say it will take the USA to repudiate, or threaten to repudiate its debt before it does that. Really the USA doesn't even have to do that. The USA is holding tangible assets, Japan & China are holding paper that is becoming more worthless by the day. I think the USA wants a monetary crisis because its holding real assets. After that, you can expect a huge rally in the Yen, and alot of reform in Japan to deal with its lack of competitiveness. Its the kind of crisis Japan needs.

Actually probably the greatest rival to the AUD for the carry trade is likely to be the USA. The Fed is currently subsidising short term rates to delay the inevitable rise in interest rates in an election year. You can expect that the USA will lag on rate increases whereas Australia is having an early start because of the strength of its economy. The housing boom has ended in Australia, but alot of new investment is going into mineral export capacity, eg. nickel, coal, iron ore, natural gas, mostly being spent in WA. This investment in the short run will boost domestic demand, so the economic outlook remains strong, with investment offsetting a weak consumer sector being hurt by rising interest rates on home loans. I wonder the extent of variable home loan exposure in Australia. If there was high awareness of inflation then maybe Australian consumption might hold ok. At some point there will be a shift to the USD/JPY, but it will flow back to AUD/JPY when that mineral export capacity kicks back in. Remember the bulk commodities market remains tight. There is inflation, but this is no bust. There is no huge over-capacity, so any slowdown will be painful but it wont create a huge overghang of capacity for some time yet.
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Andrew Sheldon www.sheldonthinks.com

Outlook for the AUD - a brave man's forecast

Reading some commentary on the Australian dollar I seem to be at odds with most of them. The SMH asserts “The Australian dollar may fall 7% in the next two months as commodity prices weaken and global equities decline”. The AUD reached a one-month low of USD90.97 last Thursday, down from its high of USD94.98 on 29 Feb 2008 – last reached on 29 March 1984. The argument for a weaker AUD is “The commodity story from here will be mixed to negative and risk appetite is being unwound”. On that note I am in wonder – where is the risk:

1. Commodity prices are resilient because of the weak USD. Where is the compelling evidence for a stronger USD? I can see some weakness for commodity prices but not a great deal.
   
2. Commodity prices are mostly (coal, iron ore, bauxite) sold forward on 1 year annual negotiations and prices are higher than last year along with volumes
3. Agricultural commodities are set to be a contributor since the drought-breaking rains last year, so might we expect added zest to the AUD on those export flows
4. Australian consumer confidence has slumped so we can expect weaker imports
5. The spread with Japan is even better at 6.75% since the BOJ is offering 0.5%. You might think this is a problem because Australia is a commodity currency, but consider markets are driven by yields and capital growth. I don’t see much prospect for capital growth in the current market, so I am confident the AUD will get supported on the basis of yields. Why else would you buy bonds?
6. Australia’s public debt as a % of GDP is the best in the developed world at just 15% of GDP. The only positive legacy of the Liberal Party. That gives the current government a lot of capacity to soften any downturn with public spending. One might make the argument that Australia has huge private debt, but its mostly real estate stock and it could be readily absorbed by higher migrant inflows. I would not be surprised to see the Australian Labor government lift immigration intakes, though it will need to pay off the Greens with more national parks and windmills.
7. Australia is one of the governments that has raises interest rates, so preserving the attraction of the AUD for the Yen carry trade. The cash rate for the AUD is 7.25% after the RBA raised rates this month – thats a 5% spread over the Fed’s 2.25% on March 18.

I have just one qualification – money supply growth in Australia based on statistics I downloaded on the weekend is very high. In fact its at historic highs. The positive implication is likely to be that the Australian government will reign in that money supply by raising rates, at a time when the Fed could possibly lower them more. The USA is going into recession, and more importantly it faces an election.

“Risk aversion remains the dominant factor holding back the Aussie against the US dollar” according to Commonwealth Bank chief currency strategist Richard Grace. I don’t disagree with this, but that is the basis of buying opportunities. The reality is that no where is there growth prospects, so true no one is looking for growth from Australia, however I think the agricultural sector will surprise the market. I also think yield rules in these conditions. Australia is also a significant natural gas exporter and commodity prices in US terms still look good if you agree that the USD is going to its all-time low of 85Yen. I would suggest that Australian commodity export capacity is alot more tangible than the USD banking system. The gold sector is going to be another great performer for Australia in coming years. The other factor supporting the AUD is likely to be efforts by Asian governments to boost their domestic economies in the wake of a weakening US economy. Its worth considering the capacity of Asian governments to do this:

1. Australia – public debt 15% of GDP – but high external debt
2. China – public debt 21% of GDP
3. Korea – Its public debt is 23.8% of GDP
4. USA – Its public debt is 36% of GDP - but high external debt
5. UK – Its public debt is 43% of GDP
6. Canada – Its public debt is 55% of GDP
7. India - Its public debt is 58% of GDP
8. Germany - Its public debt is 65% of GDP
9. France - Its public debt is 66% of GDP
10. Taiwan – 121% of GDP
11. Japan – the Japanese public debt is 182% of GDP

If anyone has the capacity to lift spending its probably the USA, but I don’t expect it at a time of rising global inflation. I think the Democrats will raise taxation.

Lastly I want to reiterate - I dont see depreciation - but there will be alot of pain for holders of debt that is not fixed. You should have fixed your property loan rates, at least for the next 5 years.

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Andrew Sheldon www.sheldonthinks.com

The USD-JPY soon to test Y100

The USD-JPY has recently found some support at 96.5Yen, though I still believe the USD is going weaker. I was actually surprised by how easily the 100 yen level was broken. Maybe it was just a reaction to the Bear Stearns failure, but I think the market is going to need more convincing that other financial institutions are not going to fail.
There might also be some market trepidation with the US presidency up for grabs. Looking at the chart above its apparent that the US dollar has been stronger over the last 5 days. I think its fortunes will be far worse next week. It was always going to retest that previous Y100 level it broke so easily. So having reached Y100, I think it will be fall back, eventually reaching the Y85 level. If I am wrong, we will know early next week.

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Andrew Sheldon www.sheldonthinks.com

Trade the AUD from Y90 to Y100

The following is a discussion I had on Japan Forum. Got a debate going on the outlook for the AUD against the Yen.

[QUOTE=tanmedia]If NZ and Australia have a debt crisis, there will be pressure to cut interest rates. The Reserve Banks of both countries are between a rock and a hard place at the moment.

Rising energy costs yet some of the highest debt in the developed world.[/QUOTE]

No question there will be a debt crisis but you need to consider 2 things: (I) Australia, and particularly NZ have run much more disciplined monetary policies than the US, so rates never sank to the level of USA, and Australia was far more prosperous. There were 'no doc' loans in Aust, but not to the same level of abuse. (II) The drought appears to have ended, so thats another $6bil of export revenues for next year at a time of rising prices.

[QUOTE=tanmedia] "The Aussie is hostage to competing forces rigth now. On one hand, the endless rise of world commodities prices and the great fall of the US Dollar are good reasons to back the Australian currency. Indeed, Australian exporters can take full advantage of rising gold, metals and energy prices." [/QUOTE]

Well most of those commodity price rises are due to falling USD of late so mixed impact. Precious metals are rising in real terms, base metals are falling. Bulk commodities like coal and iron ore are doing very well. But AUD is rising also because of agric export outlook and higher interest rates whilst US cutting its rates. So I agree with you there.

[QUOTE=tanmedia] "On the other hand however, there is a new event on the FX markets which is bearish for the Aussie: the liquidation of carry trades. Those long-term positions were based on the different interest rates on government bonds in different countries (a basic carry trade being to buy the high yield currency and sell the low yield one). [/QUOTE]

Eh, I thought we just agreed the outlook for AUD was good. I see it breaking $1 parity no question. But maybe you are talking in terms of USD.

[QUOTE=tanmedia]"The dominant carry trade of the last few years was a strong bearish force for the Japanese Yen. It was cheap for global spculators to borrow the yen because of ultra-low interest rates in Japan for years. Since last November roughly, investors become more and more risk averse, fearing a global slowdown and the unknowns of the credit crisis. [/QUOTE]

I think the crux of this argument is whether relative yields are important or absolute yields, and I would suggest relative yields, plus monetary policy. Aust is showing a tighter policy than Japan, so all things being equal, I think we are looking at Y90 being support for the $A. I think the carry trade is not one trade, but some with a long, others with a short term perspective. What forex traders also fail to see is the bent up demand for commodities, ie. The 100 ships waiting off newcastle port, the planned mines which cant get mining equipment. That is keeping metal prices along with strikes.

[QUOTE=tanmedia]"So what have they done? Yen carry traders are getting out of long-term winning positions to lock in profits. They're also making a big change in their asset allocation, which should favour commodities. That's why the Yen is currently in a massive up trend. It's rallied against all the high yield currencies, including the Aussie."[/QUOTE]

Looking at the AUD-JPY, I can see a great looking trade from Y90 to Y100. I think it would be imprudent to expect more. I think you'll find your market comments are old news and pundits are about to jump back into AUD, whilst some will just continue to hold it. The higher agricultural export volumes & prices will take time to come. Terms of trade should improve as well. Can you say the same about Japan with oil prices at $105-115/bbl. Australia producers about 30% of its oil, but add in NW Shelf gasm and it has a net fuel balance.

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Andrew Sheldon www.sheldonthinks.com

George Bush believes in a strong USD

President George Bush said in the wake of the Bear Stearns bail-out, that “the US believes in a 'strong dollar”. Does that give you confidence? Surely that news is likely to push the USD to its all-time low of Y81.12 set on 19^th April 1995. But we are a long way from that. I suspect the motive for the comment was to calm those governments holding large amounts of US treasuries, namely Japan, China and Saudi Arabia. Afterall why would a foreign government want to hold a basket of bonds in a depreciating currency on which real yields are also falling. So that’s the rhetoric to support buyers. Which raises the issue of whether the US government will have a problem financing its deficit. The US has had a succession of tax cuts under Bush, with the economy oftening it looks like there will be a series of tax increases in future. On the other side, who wants a weak currency at a time of weaker economic growth? Where is the value when most of your competitors are pegged to your currency? Only the Euro and commodity currencies like Australia, Canada and NZ offer competitive advantage, and they are not significant markets.

Currently the USD is trading at 98.05, well below its 2005 low 0f 101Yen. The doubts cast over the US economy, the high oil prices, the prospect of weaker global growth all seem to support a weaker USD, and more importantly the Fed is about to cut the Fed rate by another 1% to at least create the myth that there will not be a recession. The high oil price in USD terms is sure to undermine local spending too. It could not look much worse. The positive of course is that the USD can repay all its debts by merely flooding the world with USD. It is left holding a lot of very tangible assets, whilst Japan & China can monopoly money. But we are years away from that. Its all payback of course for the mercantilist policies in those countries. So sit back and watch the USD fall to 81.12 Yen. I actually though it would come later, but the Bear Stearns bail out will undermine confidence in financial institutions. I give the Fed credit – they are great at managing perceptions. If only they could manage money better.

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Andrew Sheldon www.sheldonthinks.com

Hail to the Yen!

Anyone who knows me knows I like an argument. Call me a tease, provocative, a dick, etc, but nothing gives me more pleasure than challenging myself. Gets me thinking, and it gives me more motivation to write. So today I had a good discussion with Ken at www.gaijinpot.com/bb/showthread.php?t=49871. We are discussing the merits of buying foreclosed property in Japan.

Ken said: I expect the USD to stay weak during 2008 but rise again in 2009. I don't see the J-government/US government letting the yen go through the roof against the USD like it did in late 1990's. Bottom line: the USD is the generally the stronger currency.

Andrew said: The US 'has' been the stronger currency, but that need not been the case in the future. Its not an arbitrary principle. The reason why the USD was strong was because the economy was growing, and all that debt was performing well for Americans. But asset prices are in reverse. Which means the cost of living has to rise whilst debt is liquidated. Its a double-whammy to restore monetary equilibrium. Why should the USD strengthen? Of course it will as a short term trade. Sure there will be interest rate increases, but they will lag inflation.

Ken said: Because it's not going to crash all that much against the yen. The yen is still over 100 yen to the USD. The J-government does NOT want the USD to fall below 100 long term and will resort to currency manipulation as it has done many times in the past if need be.

Andrew said: I think the problem with those arguments is that they are old. The paradigm has changed. Spending will fall off alot in the USD, so there is no point being competitive in the USA. Asian currencies are rising, and the Euro, this is where the Japanese exporters will be making more money, not to mention the Middle East, Russia and other commodity producing countries. Japan has been shifting increasing capacity offshore anyway, so only high value production retained in Japan. Japan is almost at a point where it is a holding company like Britain, with most low-value product manufacturing is located offshore.

On your last point, it was easy for BoJ to manipulate the currency when the US economy was strong. But not its not, the carry trade is being unwound. Where will Yen go? Sinking USD, sinking US assets? Nope. Some will go into metal commodities, some into agriculture (in USA & elsewhere), some into commodity markets, but most will go home, afterall Japan is the world’s third largest economy. So Japan starts to look quite good! Weak exports, but some sound basis for domestic demand. Its a more compelling story with reform, but looks ok.

Japan will copy Korea - nice irony dont you think

Ken said: The fact is the J-government does not like a strong yen.

Andrew said: Well they didn’t like a strong Yen for the sake of exporters. But like I said, that 'mercantilist policy' has had its day. In the next few years you will see that change. You will see Japan shift to a strong Yen policy, and I suggest there will have to be a policy of economic austerity measures to make Japan more competitive. I think the fact that Korea is taking that path is actually likely to lead Japan to take a similar tact.

Ken said: Old or not the fact is the J-government prefers a strong USD to the J-yen.

Andrew said: Ken, are you 44yo, or born in 1944, because you're being a headstrong traditionalist mate. It might be time to give up the 70s disco scene and embrace the kabuki. Yen will take the lead.

The debate continues…..www.gaijinpot.com/bb/showthread.php?t=49871.
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Andrew Sheldon www.sheldonthinks.com

Outlook for the USD-JPY

This chart highlights the long term decline in the USD as a result of currency debasement. They all do it, though the US is worse than any other country. Why? Because the USD is the base currency, that is the the currency in which most debt is priced, and most commodities are sold. This is a powerful position because it means that the USA has the power to debase its currency, yet still repay its debt in its own currency. So if the USA is debasing its currency it has a huge credibility problem.
You might ask - Who would care? Well you might think the Japanese, Chinese and Arab governments who are accumulating large amounts of US debt. But no - that is not apparent. We dont see alot of complaining from those quarters. The reason is that they see opportunity where others see problems. The opportunity is:
1. Higher interest rates in the USA
2. Reform of this poorly structured monetary system
3. Continued economic prosperity in the interim, which they profit from, whether its sales of Chinese & Japanese exports, or purchases of Arab oil.
In this last chart we can see that the USd-JPY has stabilised in the 100-130 Yen range. Currently the USD is trading at 107 yen, and I believe it will return to 100 yen, last reached in 2005. Once again the fall in the USD is being orchestrated by a decline in the Fed Reserve interest rate. At that point, there is really two ways for the government (likely a Democrat govt) can address its issues:
1. Increase interest rates and taxation
2. Print USD to repay all those foreign holders of US treasury notes, or some combination of these 2 options.
3. Reform the economy
The US is already one of the most vibrant economies in the world by virtue of the US values system and its dynamic, free-thinking people. But government works in mysterious ways. We have already made the point that the USA benefits from the current monetary system. But I suspect the US might be willing to debase its currency to get Japan and China (and Asia for that matter) to legitimately price their currencies. At some point, these countries will have a large portion of their savings in US treasuries.
I wanted to provide this forecast of the outlook for the USD-JPY for the sake of property investors in Japan. Refer to my report on Japanese Foreclosed Property 2008.
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Andrew Sheldon www.sheldonthinks.com

Weaker USD-JPY in the short term

As we can see from the chart below we are looking at the USD felling to the JPY101.8 level in the short to medium term. The rationale for that is the more vulnerable US economy, the prospect for an Fed rate cut in the USD, and the unwinding of the carry trade.
At some point in time the USD might fall through this support, but it remains strong for now. Longer term I think it depends on what Japan does to arrest the impact of a softer economy. Historically Japan has been a country capable of radical reforms. eg. The Black Ships, Meiji Era, post-WWII reconstruction. But first it needs to develop some backbone. The current generation of Japanese people just have not suffered enough. The transition continues slowly.

It will take a charismatic leader with good advisors, but unfortunately they are likely to have streaks of nationalism in their air, so lets not hope for too much. But in true Japanese style, its just as likely to be just another pop-facade, ie. Kozumi - Mark II. My favourite Japanese politician is the Major of Nagano. He is a very smart guy, and he rides to work on a Harley Davidson with a side car if I'm not mistaken. Legend! Dancing with Richard Gere makes Kozumi a poor second. Having said that - you an't take Japan too seriously. Not for the time being. The US economy is by far the more flexible economy, so they are the odds-on favourite to hold that support at this time despite their problems in the debt & property markets.
- Andrew Sheldon www.sheldonthinks.com

Range trading & consolidating in JPY-EUR

I actually dont forecast much variability in this cross-rate. I see both markets soft with global demand. The JPY will be strong because of the unwinding of the carry trade, but exports will be weak anyway with the US, though might hold up somewhat in Asia. So I largely see consolidation in this market. So expect range trading between JPY143-168.
The promise of reform looks stronger in Europe at the moment, but then they will struggle with their currency issues and I think a softer Japanese market could actually push reforms there long term. But first they need to find a leader with balls.
Japanese personal debt levels are not so high, so there is some possibility support in the domestic economy. But since the Japanese consumers are easily spooked, I dont see that strength for some time. We also have to remember that Japanese employees are alot more vulnerable than in the 1980s since we have seen an increase in the proportion of part-time workers. The positive side is that these are mostly students and women, so in many cases they can return home or rely on a 2nd income. Though it might mean more tired single workers, thus less spending on everything - except rail transport. So if i was to invest in equities in future, I would be inclined to invest in pure rail operators without property development interests. But we are 6mths away from that bet.
- Andrew Sheldon www.sheldonthinks.com

New target for AUD-USD forex rate $US0.80

The AUD-USD has pulled back from its high of USD0.94 and is now trading at USD0.878. There are many factors working for and against the AUD - and I list the following:
Strong AUD arguments
1. There are alot of investments in commodities already in the pipeline that will feed through to higher commodity sales - albeit at higher prices. Bulk commodity prices (iron ore, coal) are locked in until Apr'08. Higher mineral and agricultural export capacity (from new new mining investments and farm restocking) will take time to feed through to export sales.
2. Australia is experiencing growing inflation. Alot of people think inflation is simply a demand phenomena, so as global growth stalls, so will Australian inflation
3. Australian inflation will require higher interest rates to offset the loss in real buying power of the AUD
4. The possibility of an improvement in agricultural exports as a result of the cessation of the drought
5. A fall in domestic spending will reduce imports, and in the short term strong export receipts should result in a much improved terms of trade, but the flight of dollars into JPY (carry trade) will weaken the current account deficit, and the AUD.

Weak AUD arguments
1. Higher interest rates and the deleveraging of the global economy are likely to unwind the carry trade that sees institutions selling JPY and buying riskier, higher yielding growth economies (currencies) like AUD, NZD, CAN. I think these funds will end up in the home economies.
2. The prospect of a slowdown in global growth is already affecting the perceived long term attraction of AUD. Commodity prices have actually been surprisingly resilient. I see 2 reasons for this: (i) China has yet to respond to the slowdown in the USD. As usual they tend to be the last to pick up on global outlook. They will slow purchasing only when they see softer orders. (ii) Weaker USD is actually helping support the USD price of these commodities. (iii) Post-Xmas, pre-Chinese New Year buying.
3. Higher inflation in Australia will undermine the real value of the AUD
4. Economic uncertainty, high household debt levels, rising interest rates, falling equity and property values will undermine Australian household consumption, which will slow economic growth.
5. Australia is more vulnerable than the USD because it is a smaller currency market - so there will be a flight to avoid volatility.
6. Interest rate differentials will not help the AUD because they are being achieved on the backdrop of economic softness, so the prospect of higher interest rates in Australia, and forecast Fed easing does not move me for now. Its also true that I think the Fed easing will do little to support the US economy, though will likely be justification for a short term rally in the Dow Jones.

As a result of this analysis I see the AUd-USD falling back to the strong $US0.80 support that was established between Jan-04 and Jan-07. Having reached that 'over-sold' level, I think you will see a retracement to $US0.87, and thereafter alot of consolidation for a number of years until debt levels are cleared to some extent, existing global industrial capacity re-absorbed and asset prices rising again. No doubt traders will have some fun in the currency market. But the lesson is - go easy on the leverage - this is a time for economic shocks. eg. Companies disguising weaker earnings, accounting scandals, failed banks and hedge funds. It has already started. This week the $US16 billion writedown by Citibank, then $US11billion by Merril Lynch.
- Andrew Sheldon www.sheldonthinks.com

Commodity based currencies in play

It is in times like these that you want to be trading the commodity based currencies. Why? Because markets are undergoing a change in perceptions - they are adjusting their growth & inflation forecasts. No currencies in these circumstances are better than the A$ - against the USD of course since commodity prices are based in USD. Looking at the charts:
1. AUD-USD: Its apparent from http://finance.yahoo.com/q/bc?s=AUDUSD=X&t=5y&l=on&z=m&q=l&c= that the AUD is at the base of an uptrend. You might legitimately ask - if this the end of the uptrend? I suspect it is not for this reason - base metals are still relatively strong and gold is getting stronger. Indistrial commodities like iron ore and coal are priced on the basis of 1 year annual contracts - those are currently being renegotiated. We might expect some weakness in iron ore & coal, but not alot. But expect delays settling. Looking at a short term price chart, and they are not the best charts, but they are the best I can do on the road - http://finance.yahoo.com/q/bc?s=AUDUSD=X&t=2y&l=on&z=m&q=l&c=. Here we can see that 0.79c looks like the best support for the AUD.
2. CAN-USD: The Canadian dollar is actually fairing alot better than the Australian dollar. The reason for that might be the fact that Canada exports alot of oil to the USA, though Australia also has some advantages. Australia is a bigger gold exporter, and Canada more reliant on base metals. Having said that Australia I think is poorly positioned to retain its status as a large gold producer. The bulk of exploration is moving offshore. The stark reality is that Australian explorers are seeing icey Greenland as more attractive than Australia. It must be a short mining season.... and I would hate to be carrying their heating bill. Pity the investors in that new float. Looking at the 5yr chart - we can see http://finance.yahoo.com/currency/convert?from=CAD&to=USD&amt=1&t=5y that the CAN$ is off its recent highs as oil prices got close to $US100/barrel. Recently they found support at USD parity ($1) http://finance.yahoo.com/currency/convert?from=CAD&to=USD&amt=1&t=1y, and it seems likely that we will see further short term strength in the CAN$, but dont count on it. Whilst oil prices might be strong, I think the broader economic outlook for bae metals will pull down the CAN$. I see weakness down to 95c support.

- Andrew Sheldon www.sheldonthinks.com

History of the USD - from 1970

Its worth at this point pondering the history of the USD. People talk about currencies as if they are a measure of value, but in fact thats not really the case. There are 3 things that determine the relative value of currencies:

1. The relative value of the base currency its paired with

2. The sustainable value of the currency for trade and investment

3. The short term speculative value of a currency in terms of its yield

Any class of asset that offers liquidity like the forex market can be traded successfully. So looking at the USD against the British Pound Sterling (GBP) we can see that the USD was strong in the early 1970s on the back of strong economic growth, but as inflationary pressures arose in the late 1970s it fell off considerably. In the early 1980s we have another long rally in the USD as the Fed chairman Paul Voelker aggressively raised interest rates to eradicate inflation. Thereafter there was a period of consolidation which corresponded to pretty goof economic growth in the 1990s. Its noteworthy that the USD was stronger during the brief 2000-1 US recession, but the USD has been weak in the US ever since despite strong US economic growth. This occurred because the Fed reduced interest rates to a record 1%.

There was a brief period of USD strength in 2005-6 as the Fed responded to inflation fears. But from Sept'07 the USD has weakened as the Fed focus has shifted to the weak economy. I frankly am not so confident that the Fed will engage in another period of lower interest rates. I think the market doesn't understand Ben Bernacke's intent. The intent of the Fed will always be to give confidence to the market, and it does that by saying that it will 'drop money from helicopters' to stave off recession or depression. I think the only time a government could do that is during depression or war time. For this reason I think Bernacke will step in and raise interest rates as soon as there are signs that inflation is growing. Since we can't have much faith in the CPI as a measure of inflation, we need to look at other tools, eg. Your shopping basket cost, growth in wages. These are the more reliable trustworthy tools for monitoring inflation because they are price-taker markets.

The problem is that higher interest rates will not eradicate inflation. Inflation is the markets way of correcting an imbalance between the amount of money in the economy and the sustainable level of output. If you expand an economy at such a rate and use debt to finance even faster rates, you can only preserve low inflation as long as speculative asset bubbles are inflating. This process takes pressure off staple prices (because the price increases is borne by asset inflation) and delays wage demands since wage earners are benefiting from stronger property prices and regular work for the family.

Once asset prices fall, there needs to be a corresponding rise in prices to offset the imbalance, as wage earners are now looking for higher wages to restore their purchasing power as prices rise. Inflation keeps rising not because inflation has not been eradicated but because there is still excess money supply in the economy.

I believe in the short run we are looking at a weaker US and global equity markets as Bernacke lowers rates to resuscitate them. I believe he will ultimately be forced to move hard on interest rates as inflationary expectations rise, forcing demand to soften. At that point I think the environment will become a non-issue.

- Andrew Sheldon www.sheldonthinks.com

Dont ride off the NZ economy

I dont see an increase in the NZ overnight cash rate. Dont see 50bp rise, more likely they will hold, with a 15% chance of a 0.25% increase. On the negative side (in favour of rate increase):
1. New Zealanders dont save
2. Need to rein in credit creation in an inflationary setting (ie. real rates are lower)
3. Growing inflationary outcomes worldwide - but not recognised by the Fed
4. Central banks are generally not inclined to make big steps unless they want their impact to resonate. A 0.5% would kill off the economy when there are strengths emerging.
5. New Zealand farmers are already being punished by a strong dollar and rising costs

On the positive side:
1. Previous rate rises are already having an impact
2. The outlook for NZ exports (food in particular) is very good
3. NZ is principally a food exporterYou watch food prices take off over the next few years.
4. The carry trade remains in place
5. Softer global ecoonomy

The good news is that this will restore earnings to farmers who have until now been struggling under low prices, high fuel/fertiliser costs and rising interest rates. I think we will increasingly see the corporatisation of farms globally in this period. The consequence of this will be:
1. Acquisition or merging of farm interests around the world by corporate players for subsequent listing on the stock exchange.
2. Amalgamation of farm holdings under a few very large companies with interests that integrate farming, processing and retailingHopefully farmers will see what is happening and not sell off the farm too cheaply. Fortunately they are already benefiting from an oversupply of credit. But you can expect corporates will pay even more for properties IF they can generate an income.

Why will this happen?
1. Because farm prices have lagged the increases in other commodity prices. Just look at the components of the CRB Index. See www.crbtrader.com.
2. Because its a global trend - towards greater global integration - and it makes particular sense in agriculture because farms are under-capitalised, often lacking the benefits of skilled technical resources, climates are shifting around the world because of the 'natural' heating and redistribution of rainfall.
3. Because where there is money there are investment bankers
4. Because farming is no longer a lifestyle - its a business and deregulation has globalised the agri-market
5. Because the use of farm produce in biofuels will lift demand, along with growing demand for agri-products in emerging markets (eg. China, India) as diets change.
6. Corporate entities want to increase market share
7. Corporate entities are comfortable operating in multiple jurisdictions
8. Corporate entities want to diversify operations to preserve stable earnings as well as offering segmental market focal advantages

The leaders in this process are likely to be:
1. Investment bankers, eg. Rand Merchant Bank, Macquarie Bank, Elders
2. Resource-retailers, eg. Wesfarmers, Woolworths looking for vertical integration
3. Some more wealthy and commrcially astute farmers
4. Existing listed agricuktural companies, eg. Australian Agricultural Co (ASX.AAC), Australian Wheat Board (ASX.AWB), etc.

Its actually interesting to see how events transpire because currently farmers are being squeezed by rising costs, stronger currencies, low prices, and even droughts in some markets. This is why I think we are starting to see take overs of agricultural assets, eg. Namoi Cotton in Australia. Who is next? Dont forget the baby boomers sitting on productive (but small) farms are likely to be considering selling off in preparation for retirement. They will be looking at the relatively high prices for land and saying its too hard, my kids are not interested in farming, its time to sell-up and move to the coast and retire on a waterfront. Farmers looking to expand their interests will be in acquisition mode. Other targets are likely to be farmers reeling from drought, low prices or hedge contracts that went wrong. This is all fertile ground for the investment banker.

So looking at the NZ dollar....we need to consider:
1. Central banks need to control inflation
2. Loss of competitiveness of a strong NZD
3. Weakness of NZD due to a subdued global economy (USD)
4. The seeming intent of the Fed to push for lower interest rates - forcing the hand of the European Central Bank (ECB) to follow suit, or again sustaining the unhealthy US economy
5. Weakness of the NZD if the Japanese carry trade unwinds

I dont see the Reserve Bank of NZ increasing rates at this time....I see it holding current rates. If the ECB follows the Fed, and there is another cycle of easing rates, the NZ will remain strong, undermining any need for a rate rise and the NZD will anyway be supported by stronger exports. If the ECB doesnt follow the Fed, and the Fed waits (as I expect), then we can expect the status quo (thats short term trading conditions...you needing to sell into rallies). Eventually of course inflaiton will unwind the carry trade.

- Andrew Sheldon www.sheldonthinks.com

The $AUD looking at parity with the USD by Jun'08

The AUD has been one of the strongest performing currencies this year, and there is no evidence of that changing soon. In fact there are good reasons why we can expect the AUD (currently at 0.86USD) to reach parity in the next 12 months. This is likely to occur on the back of strong export price settlements next year, which will likely coincide with a rise in the Reserve Bank's rate.
The $A is performing well because of the very favourable terms of trade, as the economy continues to benefit from strong export prices for mineral commodities, as well as an improving outlook for the farm sector. We can expect a breaking in the drought as well as higher global food commodity prices. On the domestic front, production capacity and labour markets are very tight, so there is every likelihood of strong business investment to lift productivity. A number of businesses and state governments have flagged the need for greater infrastructure spending. The long (100 bulk carriers) queues off Newcastle port are a testimony to the shortage of export capacity at Australian coal ports. Housing vacancy rates are also very tight, and whilst interest rate increases can be expected, there are several reasons why a strong AUD will be prompted by positive developments:
1. The stronger AUD will help reduce inflationary pressures - since imported items will be cheaper in AUD terms
2. The stronger will support alot of portfolio investment - particularly in mining and agriculture
3. The high levels of debt will discourage government from lifting interest rates significantly
4. Growth in incomes will fuel a 2nd rally in the property market

- Andrew Sheldon www.sheldonthinks.com