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AUD ready for pounding; echoes of UK banking woes in Australian mining sector

The resilient performance of the Australian dollar is similar to that of the pound, before the financial crisis sparked a slide in sterling, warns UBS.

In particular, the Swiss bank says, AUDUSD stubbornly trading above parity is reminiscent of GBPUSD trading persistently above $2.00 for much of 2007, before diving as low as $1.35, as turmoil erupted on the world’s financial markets. Mansoor Mohi-uddin, managing director of FX strategy at UBS, says in 2007, sterling was a favourite of Asian and Middle East reserve managers, just as the Australian dollar has been this year.

At the time, the Bank of England’s (BoE) base rate was 5.75%, making sterling a high-yielding leading currency. Similarly, with the Reserve Bank of Australia’s (RBA) cash rate at 3.5%, the Australian dollar is the highest-yielding leading currency.

Mohi-uddin says, as GBPUSD looked overvalued on any reasonable measure in 2007, investors kept trying to short the currency pair. However, GBPUSD traded as high as $2.12 at one point, forcing shorts out of their positions repeatedly.

He says the Australian dollar’s price action above $1.00 against the US dollar in 2012 is remarkably similar, with foreign reserve manager demand again keeping the currency at historically high levels.

Mining sector critical

However, when the UK’s core economic sector – the financial industry – faltered with the onset of the credit crunch in 2007/2008, sterling fell sharply across the board, as the BoE was forced to slash interest rates.

Mohi-uddin says in Australia, the comparable industry is the country’s mining sector.

Indeed, with iron ore prices falling amid fears of a slowdown in China, many are questioning whether Australia’s mining boom has peaked.

The RBA does not believe that to be the case, with Glenn Stevens, RBA governor, in August claiming the mining boom has one to two more years to run.

However, Mohi-uddin notes the latest capital expenditure survey for the second quarter of 2012 showed that investment intentions for 2012/2013 rose from A$173 billion to A$182 billion, the lowest upgrade since 1993/1994.

He says that matters critically for the Australian dollar, as the RBA has been willing to tolerate a high currency while the mining boom has continued.

“Any signs that mining companies will scale back their commitments could lead to a major re-assessment of the Australian dollar’s value in currency markets, just as occurred when Britain’s central industry – the financial sector – began to contract in 2007,” says Mohi-uddin.

“As the strong currency and comparatively high interest rates have adversely affected the rest of Australia’s economy outside mining, a significantly lower exchange rate may be required to restore growth.”

UBS suggests investors should consider deep out-of-the-money Australian dollar puts to hedge such risks.

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