Wednesday, July 15th, 2015
A year ago we forecasted that the $A would fall significantly. At the time we said the potential currency decline created an opportunity, particularly for savvy SMSF and self-directed investors, to shift funds offshore and benefit from the weakening local currency.
That play paid off: If an investor with $1 million to invest at June 30, 2014 had put $300,000 into a $US international fund, the weakening $A meant those funds would have earned about 18 per cent.
If the investor had left the other 70 per cent in an Australian term deposit, the whole portfolio would have returned around 7.5 per cent – that’s double the return of the Australian share market and with a lot less risk and volatility.
Figure 1. AUD/USD currency exchange rate
Source: Thomson Reuters
The success of the strategy highlights that asset allocation strategies like this are becoming increasingly important for SMSF and self-directed investors.
The good news is we think there is an opportunity to play the weakening $A again this financial year and not only for international investing.
$A: further to fall
You may have noticed that the $A has fallen sharply since the start of the new financial year at June 30. It’s fallen 3 cents against the $US and is even weakening against the euro during the Greek crisis!
We think it has a lot further to fall to match the declines in the prices of our major commodities, particularly iron ore and coal.
The $A also faces downwards pressure from the changing outlook developing for energy markets, not just oil, but also natural gas.
Australia’s long term export future (and the strength of the $A) is closely linked to selling liquid natural gas (LNG) into the burgeoning Chinese market.
But as Matthew Sussex noted in Putin’s Pivot: The Russians are coming to Asia, an article published in the Lowy Institute’s The Interpreter, Russia is poised to challenge Australia in supplying Asia’s energy market.
Sussex highlights that Australia is planning to meet 60 per cent of Asia’s increased LNG demands by around 2025.
“But here’s the problem,” Sussex writes. “Russia is planning to meet 100% of Asia’s increased demand by the same time, via its massive development of the Far East. And by the time its $400-billion deal with China starts deliveries in 2018, China will be importing more Russian gas than Germany does now.”
Figure 2. China’s oil imports (barrels per day)
Source: General Administration of Customs of China
We expected these downward pressures and risks to see the $A fall below US70 cents by this time next year, though timing is obviously difficult given central bank activity around the world.
Local share market winners
We have noted in the past that some Australian companies will win from the falling $A, particularly those who earn a significant proportion of their earnings in $US such as Westfield Corporation.
But if you actually deep dive into the potential winners, you realise they are a declining part of the Australian market.
For instance, the bank and property trust sectors, which represent almost 50 per cent of the market, will not directly benefit. Their valuation fortunes lie with the bond market that currently sits at historic low yields.
We note that resource stocks (15 per cent of the market) will benefit from a falling $A, but with commodity prices so weak they’ll simply tread water.
Healthcare stocks such as Ramsay Healthcare and Resmed will also benefit, but in the main those stocks are very expensive.
Some internationally exposed companies like Crown, Computershare and Seek should get an uplift.
But it’s clear the benefits to the local market of a falling $A are not as acute as they were in the previous cycle when resources were a bigger part of the market and commodity prices were strong.
The best way to win from the $A fall
So the best way to position for a weaker $A is to continue to allocate investment funds offshore and to target the limited opportunities on the ASX.
SMSF and self-directed investors seeking to buy international equities should do it in two steps. They should allocate cash in an offshore currency, mainly $US. They should then wait for the market correction that will inevitably follow the relief rally following on from the short term “Greece fix”.
The best way to implement that strategy is to invest in an international fund manager who isn’t forced to invest. That gives the investor non-$A holdings, and the fund manager can then buy stocks when quality international companies present as being in value.
Benefit from a weaker $A
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Disclosures: Clime Asset Management owns shares in CPU and CWN on behalf of various mandates where it acts as an investment manager.