Fundamentally speaking, long the Aussie

Commodity currencies enjoyed a spectacular run in 2009 with the Aussie dollar in particular surging over 27%, the biggest rise among major currencies. Granted, the country’s fundamentals are hard to find fault and the Aussie only fell in sympathy with the rest of the world amid the financial crisis. With this year’s government stimulus weaning and sovereign default becoming reality, developed currencies and their host economies are likely to wobble. But for the Aussie there appears to be nowhere but up.

The Aussie strength is supported by a variety of factors at home and abroad, courtesy of a hawkish central bank, a relatively trouble-free financial system, anemic growth overseas and, China.

RBA
RBA’s interest rate moves against the backdrop of 2.7% GDP growth are just a beginning. Steady unemployment data and an overheating property sector lay the ground for more rate hikes and rightly justify Governor Glen Stevens’ TV appearance to give warming on speculative mortgage borrowing. February’s disappointing retail sales may prompt the bank to give the status quo a second thought, but it hasn’t dampened market interest rate expectations as the economy powers ahead. At least another 50bp rise by end of September has already been factored in the economy; Complacent or over-confident, to the Australians, the country’s outlook has never been better.

Banks' lending
In hindsight, Australians have reasons to cheer for missing out on the leveraged game that bruised many connected to the U.S subprime; now they will applaud the country’s economic divergence from the U.S and proximity to the growing Asia. The big 4 Aussie banks have minimal exposure to leveraged loans overseas and their balance-sheet repairing initiatives include reducing wholesale financing and shunning commercial lending in favor of retail deposits. The over-prudent pursuit for stable funds and the over-cautious treatment towards SME market is likely to stave off many businesses, but that’s a distant worry. The more palpable effect of selective lending tends to introduce more speculative capital in the property sector and further fuel up the Aussie dollar.

Overseas Growth
Lack of growth elsewhere has also been playing a role in pushing up the Aussie. The euro zone is beset by debt problems and the Euro still hasn’t found a floor; The U.K is still hung up on the possibility of having a hung government; Japan is planning for more QE to hold down rates, carry trade against Yen is back in vogue; the irony of the U.S taking the lead for global recovery in 2010 is intriguing, but commercial real estate is a ticking time bomb and can surprise any day when the Fed still has its hands tied on underwater mortgages in the residential market. Notwithstanding this week’s non-farm payroll, if current gold price and the country’s burgeoning deficit are any guide, confidence in the dollar may have been over-played by several notches.

M&A
An uneven recovery and European sovereign concerns has brought back Asian investors’ appetite for risky assets and the Aussie as an alternative foreign reserve to the dollar. Last year’s 155b worth of deals made Australia the hottest M&A market in Asia. Not surprisingly China got the lion’s share. The communist state has been actively encouraging FDI as a way to channel out hot money and uncover offshore growth opportunities. Already the 1st quarter has seen several multi-billion deals in the Australian resources and energy sector. There’s something else in it for the Chinese government too: troubled by currency risk and driven by a desire to diversify away from the dollar, CIC, the 200b Chinese sovereign fund has made bold moves all over the world since the second half of 2009. Its 421m investment in Goodman Group, an Australian property development group, is only a tip of the iceberg. The fund has become more transparent and strategically-conscious in terms of doling out for foreign assets of national interest. It will not be surprising to witness more deals done on a grander scale in 2010

Iron Ore
Even if future rate hikes by the RBA have been priced in the Aussie, a surprising turnaround on iron ore negotiation has most certainly not. China has managed an unrelenting stance towards the U.S over issues from climate change to trade imbalances, but the same can not be said with Australia. Iron ore is currently trading twice as high as it was priced a year ago and the big 3 miners are on track to gaining client's approval to accept a more market-oriented system. Quarterly pricing is already a default setting with Japanese steel makers, the Chinese and the European are likely to follow suit. Putting too much stock on Chinese steel union’s negotiating power is as naive as hoping the entire steel industry to speak with one voice. CISA ‘s effort to get a 45% discount on iron ore prices was undermined by a 33% acceptance from neighboring Japan and South Korea but more importantly, by the lack of coherence from the Chinese steel suppliers. The government’s relentless attempt for price cuts will prove to be futile in the face of an outdated benchmark system and the country’s own resources dependency.

Underlying Strength
The Aussie is currently trading below the 98c high in July 2008 and it’s simply retreading the same path that it has trodden before. The currency has been holding up well against market gyrations since March 2009. Even worries over Dubai and a shaky Greece have been proved too far removed to have any material impact on its run-up to parity. Market sentiment over the past year has also been overwhelmingly positive with commercial and large traders taking consistently long positions in the commodity futures market.

Australia is enshrined in emerging markets demand. In the absence of another Lehman-esque type of market seizure, the Aussie is likely to reach parity by the end of 2010.