An Opportunity to Make Money from the Australian Dollar's Strength

Lance Spicer, Editor - Trident Confidential & Investment Manager - Trident Global Growth Fund, 13 Apr 2011, 2:54 PM

In the last week the AUD$ has been setting record highs and while many in the media have been cheering “the strength of our dollar”, I for one see a recession if it continues. Australia faces some very serious headwinds right now:

China raising interest rates in an attempt too cool inflation, which in turn could cool down GDP growth and commodity prices.
The Carbon Tax which has now been estimated to cost each Australian family $600-$1200 p.a.
High relative interest rates that is not only hurting property investment and construction, but also attracts investors to buy our dollar.
This in turn drives down exports, tourism, services and the competitiveness of local products, as imports are much cheaper.

The result is obviously what many Australians are feeling at the moment – pretty tough times, even though the Federal Government would have us believe these are the best of times.

It all comes back to our interest rates – they are high and most offshore investors find our first world stability attractive when you consider interest rates elsewhere. The biggest driver of our dollar now is the Japanese Yen–Australian dollar carry-trade. This where Japanese investors have borrowed money in Yen in Japan at rates of under 1% and invested the money in AUD$ denominated cash management accounts paying 6%-8%. They pocket the difference, which as you can see is very substantial.

However, there is a huge risk here. It’s the Foreign exchange risk. If the AUD$ keeps climbing against the Yen – then they will continue to make money off the interest rate differential and foreign exchange, but if the dollar falls, they could quickly lose their shirts, which would reverse the carry-trade very quickly, which entails selling (dumping) AUD$ and buying back Yen to pay off loans. To put the carry-trade in place to start off with, they effectively sold Yen (driving down the value of Yen) and bought Australian dollars (driving the AUD$ up in value).

This explains much of why our dollar is so high. Nothing more than speculation!

Now, what could cause the AUD$ to drop, because it won’t be increased interest rates in Japan after what they have just been through. What could do it, is:

Commodity prices falling
The European Central Bank (ECB) or the Bank of England increasing interest rates further – which is highly likely before 2011 is out. This would attract Yen carry-traders to switch to the safer “non-commodity risk” currencies in Europe.
Expectations that the US may start tightening monetary policy in late 2011 or early 2012, as they seem to be obsessed with keeping inflation under control
There is also a point where the dollar will become so high that the carry-trade will be a risky proposition (“crowded”) and new comers to the trade will be less willing to take it on. Obviously, as the news improves in Japan, the Yen will attract buyers making the Australian dollar carry-trade look risky.

Most of the people who seem to get these things right, from my observations, are betting the AUD$ will peak soon, if it hasn’t already and will then start its descent, which of course will send the carry-traders for the door accelerating the exit and the fall of the AUD$. If this occurs the fall of the AUD will be brutal, as compared to its slow and steady rise. My belief is that we will fall well below parity and pretty much stay there as the US economy continues its inevitable recovery.

For the AUD$ to stay where it is will no doubt cause our economy to weaken as imports rise, exports fall and jobs are lost. This will in turn result in the AUD$ falling as economic fundamentals support selling the AUD$. So, any way you look at it, the AUD$ should fall from here. Exactly when this fall will occur or if it will rise even further in the short term, is anyone’s guess.

Right now, the best way to profit from the Australian dollar is to buy US equities and this week in Trident Confidential I have identified 9 US stocks in our buy list that are within our fundamental buying range.

If, as most people suspect, the AUD$ drops back to around the US$0.90 mark by year end - you’ll have made 14% on your money, even if those 9 stocks haven’t moved a cent! However, all these stocks have great fundamentals and expanding sales and earnings so the chances are very strong that they’ll be increasing in price as well as nearly all our stock picks do.

A Fabulous Small-Cap Opportunity – Right Now!

In addition, this week we are recommending an Australian small-cap stock that is just too good to pass up. Ignored by fund managers this hidden gem has been increasing sales and earnings steadily with it’s operations both here and in Asia. It’s involved in the oil and gas industry as well as engineering and construction and has increased sales by 49% in the last half year, which in turn resulted in an an increase in profits of over 190% as a sign management are doing their job.

What’s more, earnings are tipped to increase by more than 140% in the next two years and it’s forward Price to Earnings (PE) ratio is only 5! Can you believe this company has been completely overlooked? This company also has low borrowings, produces good cash flow and pays a reasonable dividend. Our analysis has the stock at least 50% undervalued while one broker who does follow the stock, is tipping an almost 100% increase in it’s share price.

You can read all about this stock in this week’s issue of Trident Confidential - Read More about Trident Confidential at the new website or sign up.

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Until next time,

Kind Regards,

Lance Spicer
Trident Global Growth Fund - Fund Manager
Trident Confidential - Editor

Investment Manager
Trident Investment Management Pty Ltd
ACN: 136 841 426
Authorised Representative no. 339798. Authorised
Representative for Australian Mutual Holdings Ltd