Stephen Merlicek
Advisermag Investment Update

Parity party

By Stephen Merlicek

The Australian dollar (A$) has been going from strength to strength and has now1 reached parity with the US$. This is the highest level achieved since it was floated in 1984 against the US$.

As an investment team, the key questions are:

  • What has caused the dramatic rise?
  • Where will the A$ head from here?
  • What are we doing to make the most of the current high A$ and the moves that we see ahead?

How did we get here?

A major reason for the recent strength in the A$ is the relative weakness of the US$ which has been compounded by two rounds of quantitative easing by the US Federal Reserve. Evidence of this can be found in the fact that the A$ is not the only currency to have risen against the US$. Many of the world’s major currencies have been rising against the US$ and some countries are even taking steps to try to limit the appreciation in their currencies in an attempt to protect their economies.

But the weakness of the US$ isn’t the only force at work. At least part of the reason for the recent appreciation of the A$ is due to the strength of the Australian economy and, in particular, our mining industry. Our big mining companies have revenues largely denominated in US$ which need to be repatriated. This increases demand for the A$ and helps keep it strong.

The A$ is also at or close to record highs against the Euro, British Pound and the New Zealand dollar.

But there is an added indirect effect. The strength of our mining industry puts pressure on inflation which the Reserve Bank tries to keep in check with higher interest rates. Higher interest rates are attractive for international investors particularly with rates near zero in many large economies (the US and Japan for example). Foreign money flowing into the country adds to demand for the A$.

What is IOOF doing to take advantage of the high A$?

Firstly, we have reduced our hedges on overseas assets in order to benefit if/when the A$ falls, as offshore assets become more valuable if the A$ falls.

Secondly, we are increasing our weights to offshore assets on an unhedged basis. For example, many US blue chip companies are 30 per cent cheaper than they were two years ago and are at good valuations and reasonable yields.

What does the future hold for the A$?

Whilst it is extremely difficult to pick the top and bottom in the A$, history has shown that currencies do not go up or down forever and that shocks are often just around the corner.

We know that the A$ often goes up the escalator but down the lift well. Therefore, while we’re taking full advantage of the current historically high levels of the A$, we also have an eye on the future and have ensured that we’re fully prepared for when it goes down again.

This is quite possibly a once-in-a-generation increase in the value of the A$. So, while we’re taking full advantage of the opportunities it presents, we’re also looking carefully at potential risks and taking prudent steps to prepare for any sudden changes.

As a consumer, however, it’s pretty much all upside. So enjoy your new flat-panel TV and overseas holiday!

Kind regards,
Stephen Merlicek
Chief Investment Officer

1Dated 5 November 2010