The crash in commodities in the past week has been amazing to watch. Whatever the various cross-currents, it is clear that Chinese demand has slowed in the past year. Most Chinese-related asset markets, whether commodities, BRIC equity markets, or Chinese stocks themselves, have been declining for much of the past 2 months.
But there is one asset tied closely to China that has defied gravity. The Australian dollar. It has been a major beneficiary of inflows from Japanese investors who want to avoid their own weakening currency. Yet, the underlying fundamentals for Australia have clearly gotten worse. Here is a good take from the astute, experienced traders who write the Macro Man blog:
One partner of a insolvency advisory in Australia described what was happening in the Hunter Valley and Bowen Basin, both major coal mining areas as “a nuclear winter setting in”. Not a lot of room for interpretation there. Word is that if you want to finance “yellow goods” – ie, things like bulldozers and massive trucks then you generally will not get much love from Australian banks who have seen this show before.TMM have been wrong before on AUD but we are finding it hard to see what keeps it higher from here given the collapse in investment we are likely to see over the coming years. Even if the
investment flows do not do it then rate cuts cannot be that far behind.
Putting that lot together TMM feel that Aus$ is vulnerable to an old fashioned sharp move lower in a “thatshouldnthavehappened” style that is pure “Gold”.
In short, the Australian economy is quickly feeling the effects of lower commodity prices as firms shutter projects, and revenues decline as well. Though investment flows have held the currency up, I think it’s only a matter of time before the more clever crowd starts pulling money out of Australia as these negatives stack up.
On a technical basis, the chart looks primed for a big break. The 1 year chart highlights the importance of the support around 1.0170:[caption id="attachment_24913" align="alignnone" width="641"] 1 year chart of AUD/USD, Courtesy of Bloomberg[/caption]
On a longer-term basis, here is the 7 year chart comparing the AUD/USD exchange rate (black) vs. the CRY commodity index (red):[caption id="attachment_24914" align="alignnone" width="635"] 7 year daily chart of AUD/USD (black) vs. TR/J CRB Commodity index (red), Courtesy of Bloomberg[/caption]
The Australian dollar rallied much more strongly than commodities after the 2009 low, but the broad correlation between the 2 was quite positive. However, in the past 6 months, commodities have declined significantly while the Aussie dollar is flat vs. the U.S. dollar.
I am confident the Australian dollar will eventually go lower, but as with all trades, timing is a crucial issue. I think this week’s commodity crash is signal enough for me to play for a break of that 1.0170 support.
Note: This is a more speculative play than my usual trades, so I am committing less premium overall. But if it works, it should be a winner by multiples.
TRADE: FXA ($103.10) Bought the June 99 Put for $0.45
-Bought 1 June 99 Put for $0.45
Break evens on June Expiration:
-Losses of up 0.45 between 98.55 and 99, max loss of 0.45 at 99 or above
-Profits below 98.55
Trade Rationale: The FXA is the Australian dollar ETF. It will rise and fall with the AUD/USD exchange rate. If the AUD/USD breaks the 101.50 level, I think it could make a quick move back to the 95 support area. Since volatility is quite cheap (only an implied vol of 9.5, vs. 10 day realized vol around 15), I like the idea of buying a further out-of-the-money option as a speculative play for a potentially big winner if the FXA catches down to commodity prices.