The RBA has been talking down the Australian dollar as a means of boosting the weak domestic economy. It releases a widely regarded monthly chart pack. Some interesting take away from this month data shows couple reasons why the AUD could be bottoming at this level rather than plowing below 0.70c as a significant portion of the investment community expect. This complements our medium term Australian Dollar Forecast.
Australia Terms of Trade
Chart below highlight the decline in Australian terms of trade since the peak in 2010/2011. The decline reflect the fall in the commodity prices like Iron ore and coal. Terms of trade is an important indication of FX trend as it explains relative price of exports vs imports.
Important to note that current terms of trade are still elevated vs pre China explosion post 2000.
Decline in Export Prices
The decline in price of Iron ore and Coal which account for the largest portion of the commodity export sector explains a large portion of decline in Australian Terms of trade. Simply while these 2 commodity decline is gut wrenching and blood is already spilling in the streets of Iron Ore producers. We feel further downside should be priced in where the AUD is today.
Export Volumes and Capital Expenditure Waterfall
The chart below highlight our bullish view on the Australian Dollar. Even with significant decline in price of major export product. The volume increase is tremendous. The level of iron ore export is multiple of GFC levels shows the extent of the impact from non stop mining capex spend since then.
Even with moving past the peak capex spend volume growth would not fall as infrastructure is in place to maintain output (assuming current production is profitable).
Implication for stronger Australian Dollar on Australian Stocks
The factors above shows that while the decline in prices affect overall export earnings. The increase in volume offset the total impact on the broader economy. Hence even if the prices comes close to levels seen in the period immediately after the GFC (i.e $40 for Iron Ore). We would not be as bearish on the Australian dollar.
Those that are short the Aussie Dollar should also be cautious that the ramp up on LNG export volume. With BG commenced LNG export in Dec 2014 and APLNG in early 2016 with a number of other major projects like Wheatstone and Gorgon coming online. We feel the market has not priced this in AUD forward curve. After all LNG export earning is expected to match Iron ore and overtake total value of coal.
On a sector selection basis across the ASX listed ETFs, exchange traded funds that focus on specific sectors can be worthwhile in expressing thematic view on investing.
Currently Australian industrials and financials are expensive versus historical levels. This is primarily driven by record low interest rates. Individually we like resources and oil sector due to our view that there is a level of margin of safety for some stocks. For example Rio Tinto (RIO) cost of production in Iron Ore is $20 AUD free on board. This is with their output also selling at a premium to the benchmark price.
In the energy space we like Woodside (WPL) and Origin (ORG). Former for the balance sheet strength and later for earning momentum. The way we see Origin is that is it essentially a utility stock with upside growth from APLNG exports with downside capped by regulated utility business and upside from LNG export volume.
Using current forecast of AUD bottoming at this level. We are cautious on retailers, especially Myer with preference for Consumer Staples like Woolworths. Any business with strong earnings oversee will also underperform on any AUD USD Rate bounce. See our cross rate analysis on AUD to JPY and long term NZD to AUD trend.