Rudi On Thursday

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(This story was originally pubished on Wednesday November 19, 2008. It has now been republished to make it available to non-paying subscribers of FNArena).

It was August when I last explained why investors should pay close attention to the US dollar. As things stood at the time, global economic growth had landed on a sliding path and this would feed into a further strengthening US dollar. As such, I explained at the time, the worse it gets out there the stronger the US dollar should become.

One month earlier the euro had reached as high as 1.60 against the US dollar. When I pointed out the new role for the US dollar as the world’s inverse barometer of global economic growth, the greenback had already started to claw back some of the lost ground. By August the EUR/USD cross had corrected to 1.50. Today the cross is at 1.26.

A first observation to make is how strong the US dollar has become in such a short time span. We’re talking only four months and the euro has lost 24c in value against the greenback. This is normally the kind of movement one would expect to see over a whole year, if not over an even longer period.

Viewed from a different perspective though, this also shows just how quickly things have reversed for the global economic outlook. Japan has already registered two successive quarters of negative GDP growth. There’s only a few economists left (there are always a few) who still doubt that Europe and the US as well are both in a recession. It’s just that this still has to be officially confirmed.

In case anyone wondered: yes, my realisation at the time that the US dollar would make a significant come back supported my conviction in August that energy and resources in general were about to correct in a significant manner. Equally, I have been explaining to readers and subscribers since that time why I simply could not get excited about medium term prospects for gold and other precious metals either. That too had to do with my view of a stronger US dollar.

I used to be a strong believer that investors were underestimating just how much their Commodities Super Cycle was supported by a weakening US dollar. Now I know for certain that was the case.

The US dollar won’t always be the world’s barometer for economic health (in an opposite manner), but for the time being this is how things are working out and investors better pay attention to the currency. Economic indicators for the world’s leading economies are still deteriorating and growth expectations for the quarters ahead are still being lowered as a result.

The logical consequence should be a further strengthening US dollar.

One trend I have observed is that currency experts (those who agree with the above view that is) have now started redoing their numbers and targets, as the speed of developments on the currency markets has taken all by surprise. I can definitely see a trend in all those updated reviews and forecasts. This trend falls in line with what I said earlier: deteriorating leading indicators, lower GDP forecasts, stronger US dollar.

If current forecasts prove correct we should be seeing 1.16 by year end. Whether this will stop the greenback from clawing back more ground against the euro will by then very much depend on what the prospects for the global economy look like in early 2009.

This also means that a new dynamic has started to enter the Australian share market. Last time the world woke up to a resurgent US dollar, the Aussie dollar fell off a cliff. The currency went from near parity (0.97) to below 0.80 in a handful of weeks and then fell further to 0.60-0.64 where it is right now.

Reading all of the above, where do you think the Aussie dollar will be early next year?

Try US50c, or lower.

One thing to keep in mind is that there’s no such thing as a watertight guarantee in life, especially not in a global bear market for financial assets. But the above logic has withstood all other concepts and ideas since July-August and I have seen no reason to date to doubt that it will remain in place in the months ahead.

The US dollar, at this point in the cycle, acts as the barometer for global economic growth, in an inverse manner. Prospects for economic growth are still deteriorating, thus the US dollar should respond in the only way appropriate: by becoming stronger, and stronger.

Last time the Aussie dollar corrected from US90c-plus to US$80c and lower, share prices for ASX-listed exporters, even those with a dud outlook like Aristocrat ((ALL)) and PaperlinX ((PPX)), were propelled higher in no time. There’s never a guarantee the same thing will happen all over again, but what cannot be denied is that the bottom line of companies that translate profits made in USD back into AUD will receive a serious shot in the arm if the Aussie dollar experiences another leg down.

One word of caution though, and I cannot repeat this often enough: there will be a lot of noise in the market when the above scenarios do materialise. One of the usual elements of misinterpretation is that a weaker Aussie dollar somehow also works to the benefit of energy and resources companies. Since most of these companies (exporters in their own right) either report in USD or sell all their product in USD, this seems but a logical conclusion to draw.

As I have explained in the past, this is an incorrect assumption to make. Why? Because the reason behind the weakening of the Aussie dollar is of more importance than the weakening of the currency itself. In other words: if the Aussie dollar does break below US50c again in the months ahead, where do you think prices for copper, gold and crude oil will be?

I see a clear trend amongst economists contemplating a cut by a minimum of 75 basis points at the next Reserve Bank meeting in December. That could be a clue?

Of course, another way of looking at all this is by taking the view that whenever you want to know in what kind of health the global economy is, just look at the FX markets. The USD will tell you the story.

Ignore at your own peril.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(As always firmly supported by Sarah, Andrew, Grahame, Greg, Joyce, Pat, Chris and George)

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