- Aussie market moves to script
- An extreme high here?
- Plus, headwinds for Aussie gold appear
Yesterday, we left you with the idea to consider the short side of the market in the short term.
The Aussie market is duly moving to script.
The ASX had its second worst day of 2019 to begin the week. Bond yields are heading down again all over the world. The mood is bearish.
We gave you a second option yesterday too.
It was to make the most of any weakness and acquire any businesses you want to own long term.
Turn these dips to your advantage while they’re happening.
Now my mind feasts upon the idea of a Big Mac…
Let me be clear: I’m not talking about eating one!
I’m referring to what a Big Mac (the burger) can tell us about global exchange rates right now.
The Economist invented the ‘Big Mac Index’ in 1986.
The idea behind it was to find a standardised product and see what any price differentials could tell us about exchange rates.
They call it ‘Burgernomics’.
A Big Mac has seven ingredients and is dished up in 36,000 restaurants in over 100 countries.
But they don’t cost the same!
In January, a Big Mac in Switzerland costs 6.5 Swiss francs, or US$6.65.
In Russia, a Big Mac was 100 roubles, or US$1.65.
In the US, a Big Mac costs US$5.58.
Much of the variance here is explained by the relative strength or weakness of currencies versus the dollar.
As of now, the Russian rouble is arguably undervalued and the Swiss franc overvalued.
More to the point: The Big Mac Index suggests that the US dollar is overvalued against practically every country in the world.
What’s the implication for us here in Australia? The Aussie dollar could be undervalued by at least 20%.
The Economist has data going back to 1986 that shows undervalued currencies, according to the Big Mac Index, tend to strengthen in the subsequent 10 years.
Will history repeat? Probably.
But there’s a couple of points of more immediate concern worth thinking about here…
Trump’s largesse can’t last
One is how long before Trump’s spending weighs down the US dollar.
The Wall Street Journal reported last week that the US budget gap increased 39% in the first five months of the American fiscal year.
The deficit over the last 12 months is the highest it has been since May 2013.
This is happening while the going is good in America. One wonders what happens if a recession does come along.
The Big Mac Index suggests the market might soon be rotating out of US dollars where possible
It does make me wonder about Aussie dollar gold.
Aussie gold miners have enjoyed a bonanza in recent years.
But you can put most of it down to weakness in the currency here. That boosted their margins.
The Big Mac Index hints that this tailwind might be under pressure.
That’s not all…
Dacian Gold [ASX:DCN] fell 15% last week after issuing a production downgrade. Part of the problem was a shortage of maintenance personnel.
It’s a sign of labour shortages in the mining industry.
That could put pressure on wages. Combine that with a rising Aussie dollar and it could be a double whammy — especially if energy prices remain higher.
Take this idea with a grain of salt. It’s a potential outcome, and not a reason to avoid gold stocks completely.
But a rising Aussie dollar would be an interesting outcome considering the myriad calls for it to go even lower…
The AUD doomsters could be wrong
That view generally stems from the idea of interest rate differential. The 10-year yield in federal Australian debt is 1.76%.
That’s lower than in America. Theory suggests capital should flow to the higher rates in America.
It’s not so clear cut.
One factor is that the Aussie dollar appears to trade with commodity prices.
Those are quite strong at the moment.
I also remember reading that there could be an explanatory variable that involves the banks.
I can’t source it for you — I read it a long time ago — so treat this idea with some caution.
But the gist was that the level of credit creation played a role in influencing the currency.
We know the Aussie banks are very tight with their lending at the moment. Property industry players keep hammering the same point.
Credit growth is weak in Australia. That could make the market for Aussie dollars tight too.
Point being: I’m not convinced the Aussie dollar is going down a lot more.
It may even go up.
I’d be mad to be certain about it.
But keep it in mind. We’ll see as we go along if this idea has merit.
Editor, Profit Watch