Tags: ashish | advani | australia | risk | us | debt | dollar

For the Real 'No Risk' Trade, Think Australia

Wednesday, 18 May 2011 08:15 AM

By Ashish Advani

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We are entering into a fascinating stage of the growth story that has gripped the globe these days.

The yin and yang of whether we are in a growth mode or not has become very apparent with the almost daily “risk-on” and “risk-off” trading patterns that seem to be playing out these days.

For no apparent reason, we see the global markets go into a “risk-off” mode on any given day. And when we see that, we see the risk assets such as commodities, currencies (non USD and yen) and other “risky” assets get sold off. So on that day, we will see U.S. stocks, the euro, gold, silver, oil, the Canadian dollar, the Australian dollar, etc., all get sold off in tandem and the U.S. dollar as well as U.S. Treasurys get purchased.

And then the very next day could be a “risk-on” day which will reverse the pattern and we will see the U.S. dollar tank, Treasury yields go up (and prices go down).

What I cannot get my head around is how we can designate U.S. Treasurys and the U.S. dollar as “risk free” assets. If there is a severe crisis of epic proportion in the world, it is the U.S. dollar and U.S. debt. And yet, on days when the traders want to take “risk-off,” we buy the two assets that are the most risky.

I really believe we have this backwards. The most risk-free trade in the world today is the growth story of China, India as well as Asia in general. And one of the ways to play this trade without taking on undue risk is resource-related stocks in Australia as well as the Australian dollars.

Australia is the commodity basket for Asia. The abundance of natural resources coupled with the proximity to the super-growth stories of China and India has propelled Australia to the front of G-7 growth story and one of the only real growth stories in the developed world.

While that alone should be reason to continue to invest in Australian assets, Australia also has a very prudent Central Bank which has been wise in allowing the free market to determine the value of the Australian dollar (AUD).

It has resisted the temptation to intervene in the markets and drop the value of the AUD to supposedly help the local businesses. And as a consequence, they have saved billions of AUD from being flushed down the toilet as history has proven that Central Bank interventions don’t work in the long term. If you need examples, look at Japan, Brazil and Swiss central banks where their moves to counteract free markets have failed miserably.

And the current bout of the silly “risk-off” trading has dropped the AUD by nearly 5 percent. The world has entered a phase where the wall or worry is about inflation being too high in China, which means that they will stop growing and that means Australia will get hit significantly. That cannot be any further from the truth.

And the fundamentals of the Australian currency remains stronger than ever with all indications that the Reserve Bank of Australia (RBA) will increase rates sooner rather than later. In my opinion, the RBA could raise rates as early as August.

The RBA also views Chinese growth as remaining robust, citing industrial production, exports and retail sales. Given China accounts for 25 percent of Australia’s exports, this clearly gives the RBA confidence about the growth outlook.

While I do see some slow down in China, I don’t believe that the slowdown will affect Australian exports significantly. On the domestic front, last month the employment numbers were down, but that is just one month’s data in several months which was down. And one month doesn’t make a trend. The inflation numbers in Australia continue to be on the rise and the RBA has had to revise its forecast of expected inflation to be expected to rise to 3 percent which is well above their comfort level.

All of this points to some more interest rate hikes which will lead to further strengthening of the AUD.

I am taking advantage of the 5 cent drop in the AUD to add to my holdings. And I would suggest that you consider the same as well.

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