Options to exploit Aussie dollar weakness

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After having powered to 110 US cents earlier this year, the once mighty Australian dollar has fallen back to earth in recent weeks, touching a recent low around 95 US cents.

Concerns over global economic growth and falling commodity prices – together with heightened expectations that local interest rates could be cut – have fuelled the decline.

It begs the question: does this mean the Australian dollar’s rise is over, and if so how should investors be best positioned?

If the Aussie dollar has truly peaked, then it would clearly pay to have some money offshore in unhedged investments – as the value of these will rise as the Aussie dollar weakens.

For example, $10,000 invested in the US market when the Aussie was at 110 US cents would have bought you US$11,000 in shares. With the Aussie’s fall to 95 US cents, that same parcel of shares – assuming the US market had not fallen – would be worth $11,580 here.

If the Aussie were to slump to 85 US cents, it would be worth almost $13,000.

But whichever way the Aussie goes from here, as a general rule, investors should still consider some international exposure as it helps diversify and dampen the volatility of investment returns.

Because the Aussie dollar is considered a ‘commodity currency’, its movements often tend to be correlated with those of global equity markets. As we saw in 2008, the Australian dollar tends to fall when the global economy is in trouble and equity markets are falling. Yet, as demonstrated in 2009 and 2010, it tends to rise when the global economy and equity markets are improving. This positive correlation generally dampens the Aussie dollar volatility of offshore investments.

Since mid-May, for example, America’s S&P 500 index has fallen by around 20%. Over that same period, the Aussie has fallen by almost 15%. The net result is that the S&P 500 in Australian dollar terms has fallen by only around 8%.

Gaining access to unhedged international investments is becoming increasingly easier, with a wide range of exchange traded funds or ETFs available on the stock exchange, that track markets as diverse as America, Europe, Japan, emerging markets and China.

For long-term investors, perhaps one of the more attractive international investments around is China (ASX:IZZ). After its share market bubble exploded in late 2007, shares have since gone nowhere – but value has been building.

For an economy likely to keep growing around 8% a year, the market looks exceedingly cheap, with the China MSCI index ending September on a price-to-forward-earnings ratio of only eight – well below its longer-run average of 13.

At the same time, China’s currency is still considered cheap and should rise against the US dollar over time – which itself is arguably still cheap against the Australian dollar.

If you prefer the security of developed markets, there’s a range of US market ETFs to consider, such as IVV which tracks the Aussie’s value of the S&P 500 index. The annual management fee for this ETF is only 0.09%.

Of course, predicting where the Aussie dollar goes over the short-term is fraught with difficulty.

With debt problems in Europe intensifying and America’s economy struggling, the Australian dollar has fallen notably in recent weeks and could easily fall a lot further in a short space of time – as was evident during the 2008 global financial crisis.

But if Europe gets on top of its problems, and the US Federal Reserve starts printing more cash to boost its economy (sinking the US dollar), the global economic outlook could improve – and the Aussie could easily rebound and stay relatively high for a while longer.

Either way, what does seem evident is that even allowing for China’s booming economy, the Australian dollar is likely to remain above its long-run average of 74 US cents since it was floated in 1983.

Rising global commodity supply will eventually see the commodity price cycle turn down, and Europe and the United States will eventually raise interest rates to more normal levels once their economies recover.

That said, due to the rise of China, it’s probably the case that the average value of the Australian dollar over the next 10 years will be higher than in the previous 10 – say closer to the mid-80 US cents mark. Adding to your offshore exposure at times when the Aussie dollar moves above parity with the greenback should not only help portfolio diversity, but enhance longer-run returns.

Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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