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Date : 10/02/2021

Why a Rising AUD does not matter!

Currencies cannot be valued. They are priced and the price is dependent on several macroeconomic factors. These factors cause a shift in the demand and supply forces of a currency – resulting in price movements. The Australian Dollar is demanded by buyers of Aussie exports, foregn investors looking to park money Down Under, and by speculators that are betting on a rise in the price of the Australian Dollar. The supply side consists of Australian importers, Australian investors looking for overseas exposure and again, by speculators who are betting the other way, that is, a depreciation in the price of the currency.


Source: Tradingview.com

The performance of the Australian Dollar against the US Dollar has been an upward trajectory since the crash in March 2020. There are 2 reasons for this:

  • The increased demand for AUD
  • The weakening of USD

There are always two points of view when it comes to analysing currencies because the prices are always compared to a base currency. The rally has continued going into 2021, and our estimates suggest that the Australian Dollar will breach the 80 cents mark by the end of the year. The bull run in the currency brings with a lot of changes in market dynamics for companies that are operating in Australia and are exposed to AUD and USD.

Commodity Export

Given how important commodities are to the Australian economy, AUD is sometimes termed as a ‘currency commodity’. Western Australia is the largest producer of iron ore in the world, and with China’s continued buying, there has been a very strong demand for the commodity that has been sustained – increasing the demand for AUD. In addition to iron ore, Australia is a very large exporter of coal, LNG, and several other commodities that are essential raw materials for many industries. With economic activity rebounding as the pandemic subsides, the strength in the Aussie Dollar will continue.

Interest Rates

Australia has low interest rates, and they are expected to continue for a few more years according to RBA estimates. However, the interest rates in Australia are still higher than most developed countries. Japan, Germany, etc for instance have negative interest rates. This invites more investors into Australia given the interest rate differentials that exist between the two countries – leading to an increased demand for AUD. With the way the Australian economy is recovering and the RBA’s stimulus, the AUD will come under pressure. However, the stimulus being injected by the USA is far higher and thus supporting the rising Australian Dollar.

Weakening US Dollar

Our analysts forecast the US Dollar weakening to continue for at least another 6 months. USD thrives in a risk-off environment as it serves as the go-to currency. With a vaccine now boosting investor sentiments, the general mood in the camp suggests a ‘risk-on’ environment as investors are flocking towards risky assets seeking higher returns. The new stimulus measures coming in from the Biden government is boosting equities further and the dollar is weakening over the short and medium term.

Should I Hedge the Aussie Dollar?

The cyclical rotations tend to last a long time. Governments around the world will be looking to keep their currencies under check in order to boost exports, and they will also be looking to add more stimulus into their systems in order to desperately boost the sleeping economies. With rising economic activity from Australia and the increase in exports of commodities, it is perhaps time to be unhedged and reap the benefits of a further rise in the Aussie Dollar in the short to medium term.

Who is Affected?

You have more than just commodity stocks in your portfolio, of course you do, everybody does! So the million dollar question is – which stocks are affected and how do you determine if a stock is affected?

Well, ideally, you would want a company that is less exposed to the US market for its sales/revenues. Generating revenues in the US market for an ASX company means that their earnings will be worth less than they used to when the group performance is recognised and reported here in Australia. These stocks will thus have their EPS capped.

Another scenario is an ASX listed company that reports its earnings in USD. This is a pretty bad place to be in right now as their earnings and dividends will not be worth as much as they are used to for us Australians given the high AUD prices.

Yes, most of these companies hedge their exposures and reduce volatility in the short and medium term. Keeping an eye on how hedged a company is in 2021 is worth investors time going forward. A further rally in AUD may affect several stocks that will most likely not be hedged for AUD prices over 80 cents on the USD. In the long term, currency risk for investors normalise over time as these are cyclical movements that last for extended periods of time. Growth is more important than the affect currency prices have on companies.

The Healthcare Sector

The healthcare stocks on the ASX are all highly dependent on the US market for their revenues. CSL, Sonic, ResMed, Cochlear, Mesoblast, etc, all earn the majority of their revenues outside of Australia and more from the USA. This does not mean investors should stay away from these stocks, but they require closer examination to consider short-term risks. For instance, ResMed is the least exposed to USD revenues among the healthcare giants on the ASX, and there are a lot more finer details that should be considered.

The Commodity Kings

The ASX is home to some of the best mining and mineral companies in the world and most of these companies report earnings in USD. Fortescue Metals, BHP, Rio Tinto, energy giants – Santos, Woodside Petroleum, etc are all exposed to the downside risk of a weak USD as far as earnings go. As far as profits go, iron ore and copper miners are on the back of a bull run from high commodity prices. The energy sector is recovering as global economic activity is slowly and steadily coming back.

When these firms report earnings, they do so by setting a fixed currency exchange rate, however, their dividends are where the brunt of the short-term impact can be felt among Aussie investors. FMG’s dividends for instance can be exposed to lower USD and higher AUD prices. However, the weak USD will continue to boost the iron ore prices and increase the profits of FMG – therefore resulting in higher gross dividend yields in the medium term.

The Talk of the Town – Tech Sector

Most of the tech companies on the ASX are heavily reliant on the US market for their sales. Afterpay, Appen, Altium, Xero, etc, are all spending loads of money in sales and marketing to gain more penetration into the US market. Most of the tech stocks also have large percentages of their revenues coming from the USA. So are they affected? Not really, much of the valuation of the tech stocks is driven by the growth potential and less so by the earnings volatility due to forex risk. The reported numbers will also adopt a constant currency and this will reduce the impact of the AUD price movements.

Appen’s downgrade was due to a decrease in growth dynamics as the firm cut its marketing expenses during the pandemic. The weak USD will most certainly have no impact on the firm as the share price will rise in an environment with declining USD prices and increasing growth for the company.

The Verdict

Have you noticed that the first chart on most of our stock reports is the segmented revenues? Now you know why! The importance of knowing where the revenues are coming from is two fold – to understand the risk and to forecast the potential for future growth. The rising AUD is not a risk for most equity investors. It is short-term volatility that needs to be considered depending on what’s in your portfolio. Companies are hedged against currency risk and inflation or deflation in earnings is a short or medium term phenomenon.

Currency price movements work both ways. Weakening USD may impact the ASX miners earnings and dividends when they are reported in USD, but they are offset by the rising commodity prices, also on the back of a weak USD. An industrial giant that operates in the USA is exposed to the weak USD in earnings, however, as their operations will be based in the USA, their costs are reduced because of the weak USD as well.

There is a lot of talk on how the rising AUD will affect investors. But as we have reasoned our ideology throughout this piece, it should not affect the average long-term ASX investor. The health of a company’s business and the potential for growth or none there of are the important factors that determine the risk levels in an investment in the long run.

 

 

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