AUS Dolar moves
Australian Dollar: Heading For a Big Move
The Australian dollar has been one of the best performing currencies over the past few years thanks to strong demand for
commodities, rising gold prices, solid economic data and a weaker US dollar. However as good as Australian fundamentals
may be, there is an ancillary factor that has caused the Australian dollar to sell off aggressively over the past week and
that is risk aversion. The Australian dollar is setting up for a big move and the direction that it may be headed in may
surprise most traders.
Running out of Economic Fuel
The primary source of growth for the Australian economy has been demand for commodities like gold, wheat, zinc and beef
among a long list of others. Many of these goods were destined for booming Asian economies like China, whose growth
rates have breeched double digit gains. However, the strength of the export sector may soon lose its momentum. While
prices for raw materials may act as a temporary crutch, prices have begun to turn. Global growth has started to cool
according to the IMF, which lowered its forecast for annual growth from 5.2 percent to 4.7 percent, but most importantly,
the Baltic Exchange Dry Index which is a strong leading indicator for global inflationary pressures and commodity demand
plunged to the lowest level in 6 years.
Everyone knows that the Australian dollar has a strong correlation with gold prices, but do they know that gold prices are
correlated with the BDI? The relationship between the Baltic Dry Index and gold prices can be seen in the chart below,
courtesy of InvestmentTools.com. Over the past week, we have already seen a drop in gold prices, but it is clear that the
BDI tends to be a leading indicator for gold. The BDI measures the cost of shipping different commodities around the world
and if demand to ship is strong, the price for shipping these raw materials increase but if demand is weakening, the price
falls. The recent drop in the BDI is our first indication that commodity hungry countries like China and India are no longer
immune to the slowdown in the US.
Even with the export sector out of service though, the Australian economy could theoretically survive on internal
momentum. However, domestic growth trends may be fading just as quickly as the broader global trends. Business
spending (initially supported by exports and latter funding the consumers’ rise) dropped 6.5 percent over the third quarter
- the sharpest drop in nearly eight years. At the same time, the consumer sector - the largest in the economy - may be
reigning in their consumption habits. Even though the latest retail sales report was strong, for the January reading, the
Westpac consumer confidence survey fell the most in 14 months, while the gauge measuring Aussie’s outlook for the year
ahead plunged 20 percent. This dramatic rise in pessimism has been driven by increases in lending rates along with tighter
lending standards, stifling increases in gasoline prices, a sharp correction in stocks and a general dour outlook on growth. If
consumers decide it’s time to pack it in, it wouldn’t take long for growth to cool.
High Yields Become a Liability Rather Than an Asset
Another major buttress for the Australian dollar has been its high yield. Last year, the Reserve Bank of Australia raised the
overnight lending rate twice to an 11-year high 6.75 percent. What’s more, RBA policy makers have yet to turn dovish like
so many of their international counterparts. However, even if the central bank holds its high benchmark rate steady, the
appeal of the Aussie dollar may still fade. The Australian currency has enjoyed a significant bid through the carry trade
whereby traders sell lower yielding currencies like the Japanese yen and buy high yielders like the Aussie dollar. This
strategy had become very popular over the years, but there was a catch: its popularity and success are highly correlated to
low volatility conditions where the carry trade can make its steady income without the threat of capital losses. Markets
have been anything but calm over the past six months. After a subprime lending explosion in the US led to massive losses in
the world largest banks, turmoil in global credit markets and the beginning of a global turn in interest rates, all assets
associated with risk saw dramatic increases in volatility. With many of the components of higher volatility only worsening,
the outlook for the carry trade and the Australian dollar isn’t promising.
For a more in depth, fundamental outlook on the Australian dollar, check out our AUDUSD 2008 forecast.
Technicals Also Point to the Possibility of a Major Top
Currencies have freely floated since the early 1970s and since then the AUDUSD has traced out a perfect Elliott wave
pattern. The basic pattern that governs all free markets is the 5-3 pattern. That is, 5 waves in one direction are followed
by 3 waves in the other. It is obvious that the AUDUSD decline from 1.4885 (1973) to .4775 (2001) unfolded in 5 waves.
Similarly, the advance from .4775 unfolded in 3 waves. The rally ended right at .9400 (psychological level). It is likely that
the rally from .4775 is just the first leg in a larger more complex advance from the 2001 low. Why? The decline from 1973
took 27 years and the advance has lasted a little over 6 years. Still, this chart suggests that that the next big move is down
-- to at least .7633 (38.2% of the rally from 2001) and probably lower.
One reason to favor the idea that a multi-year top is already in place at .9400 is that wave C (from .6771) within the A-B-C
advance from .4775 can be counted as an ending diagonal (where waves 1 and 4 overlap). Extending a line from the top of
wave 1 that is parallel to a line drawn off of the bottoms of waves 2 and 4 pinpoints the top of wave 5. A channel as
perfect as this strengthens the argument that a significant top is in place.
240 Minute Chart of AUDUSD 01-18-2008
If the bearish count is the correct count, then wave a third wave down may be about to begin. While this count is far from
perfect, it is possible. Given the longer term bearish implications from the monthly and weekly charts, this count should be
respected. A drop below
.8682 (black line) would strengthen the bearish bias. If that does occur, then risk can be kept to .8880.
Note: The AUDUSD may be in the early stages of a bearish cycle but AUDNZD looks bullish! This suggests that NZDUSD will
fall more than AUDUSD (AUD will gain relative to NZD). See AUDNZD for more on this idea.
Discuss the outlook on the AUDUSD with Jamie and other traders in the Elliot Wave thread of the DailyFX forum.
Written By: John Kicklighter, Currency Analyst and Jaimee Saettele, Technical Currency Analyst for DailyFX.com
To contact John or Jaime about this or other articles they author, email them at jkicklighter@dailyfx.com or
jsaettele@dailyfx.com
