Key points

• New Zealand cut cash rates this morning to 2.75% and chances are increasing that the Reserve Bank of Australia will follow later this year as growth and inflation remain stubbornly weak.
• Australian dollar commodity prices may have bottomed and it could be time to selectively add high quality, low cost Australian commodity producers to portfolios.
• The S&P/ASX 200 is low risk buying around the 5,000 level, an index level that has held strongly in recent weeks.

I want to again reiterate today that dip buying of quality equities remains the right approach during this correction/period of heightened volatility.

The big bounce

You can see this week quality Australian equities bounced sharply from their lows, reminding investors and traders that stocks that fall the hardest tend to bounce the hardest.

The bounce has been triggered by stability in Chinese equities and soothing words from the European Central Bank (ECB), Bank of Japan (BOJ), and selected Federal Reserve Board members.

The reality is that central banks stand fast ready to pump more liquidity and the central bank put remains firmly in place. It is not even certain whether the US Federal Reserve will raise cash rates by 25 basis points this month due to market volatility.

My core belief is that interest rates globally and locally are going to remain historically low. You can see New Zealand cut cash rates this morning to 2.75% and chances are increasing that the Reserve Bank of Australia will follow later this year as growth and inflation remain stubbornly weak. I remain of the view Australian cash rates will have a “1” handle later this year and my long-held forecast of an Australian dollar with a “6” handle is a reality today.

I continue to believe the $A/$US cross will head to the mid to low 60’s, which is a GOOD thing for the Australian economy. It is good for our commodity exporters, good for our agriculture sector, good for what’s left of our manufacturing sector, good for our tourism sector and good for our education sector. It’s also good for our property sector as Australian property becomes cheaper in global dollars.

How low can she go?

What we really need is for the Australian dollar to stay down here for a few years. I believe that is likely and that is why in my fund I remain short Australian dollars as I have for the last few years. I am also adding to positions in Australian listed companies that benefit from both activity and earnings translation from a sustained low Australian dollar. Examples that I have bought through the correction in equity markets include BHP Billiton, Rio Tinto, Regis Resources, Echo Group and Sydney Airport.

Interestingly, it looks like Australian dollar commodity prices have BOTTOMED. In Australian dollar terms it appears to me that the prices of iron ore, copper, gold and oil have bottomed. It is therefore no great surprise that Woodside Petroleum would make an opportunistic move on Oil Search.

My point is the physical commodity prices appear to have bottomed in US dollars, but now the Australian dollar is falling faster versus the US dollar leading to higher Australian dollar prices for commodities. This is a major event for Australian commodity producers and worth noting that during this “China meltdown” the sector has actually caught a bid.

Now nobody I read has anything positive to say about China (except for Peter), let alone Australian resource stocks, but I am of the view that Australian dollar commodity prices have bottomed and I do think it’s time to selectively add high quality, low cost Australian commodity producers to portfolios.

For whom the bell tolls

There’s always an event that signals the bottom of a sector globally and in my view it was the Glencore rights issue/debt repayment/production cuts announced in London this week. Glencore floated at the absolute peak of the commodity cycle, now it is downsizing at the bottom. The contrarian in me feels that was a clear ringing the bell event with the true positive being production cuts.

So in an Australian context I tend to believe the big resource stocks either have physically bottomed or are in a bottoming process. That is a positive event for the S&P/ASX 200 Index.

That brings us again to the other major sector in the ASX200, the banks.

I remain positive on the Australian banks and I do own CBA and NAB in my fund. As I wrote last week I believe the absolute kitchen sink has been thrown at Australian banks in the last few months and I see a clear contrarian opportunity now that the capital raisings are complete.

It’s been nice to see a bit of a bounce in the sector off the lows, but I remain of the view that on a 12-month view the banks remain cheap and total returns from here will still be double digit.

The bottoming of the bank sector also coincides with seasonality support for the sector.

It’s worth noting that since 1970 that after back to back negative return quarters in June and September, the Australian bank index has returned on average 16.88% from October to April. This has occurred 92% of the time.

This could easily happen again this year, particularly with the full year dividends approaching in October/November for ANZ/NAB/WBC. Those dividends will be delivered and I think buying Australian banks on 6% fully franked yields remains a sensible investment to my way of thinking.

It’s important to note that the capital raisings have played the greatest role in the bank sector correction. The end of the capital raisings and approaching full year dividend season will be like a fog lifting from the beaten up sector and I encourage you to increase Australian bank weightings.

Low-risk buying opportunities

I know I might be telling you all that you want to hear, but my view is the two major sectors in Australian equities, resources and banks, have bottomed and have medium-term upside potential from here. I don’t doubt there will be days of volatility ahead, but I think the S&P/ASX 200 is low risk buying around the 5000 index level, and index level that has held strongly in recent weeks.

None of us will ever buy the exact bottom, but buying of down days into high quality companies will be rewarded over the next 12 months. The equity market is on sale and cash rates will come down more in the months ahead. You do need to be “greedy when others are fearful” as Mr Buffett always says.

While I don’t think we will see 6000 on the S&P/ASX 200 anytime soon, don’t rule out a bounce to 5500 as banks and resources recover from oversold levels.

It’s the perfect time to implement the Australia for income, rest of world (ROW) for growth strategy. That is exactly what I am doing for the AIM Global High Conviction Fund and I encourage you to as well.

In volatility, there is investment opportunity.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.