The Currency to Buy in Times of Crisis

On Nov. 22, the Irish government broke down and accepted a massive 85-billion euro ($113 billion) bailout package from the European Union and International Monetary Fund. The move was supposed to alleviate fears of an EU-wide credit meltdown. Instead, concerns that Spain or Portugal could be next to default have kept Europe in crisis mode.

Not surprisingly, that has inspired investors to abandon the euro (EUR), jumping ship into higher-yielding currencies like the New Zealand dollar (NZD) and British pound (GBP). But the one high-yielding currency set for the biggest short-term benefit is the Australian dollar (AUD).

Powered by a historic boom in the mining industry, Australia’s pace of expansion has fueled rapid hiring in the last couple of quarters. Reported employment growth in the Pacific economy has averaged around 35,000 positions a month since the beginning of the year. This labor expansion has helped to lower the national unemployment rate to only 5.3% – compared to the US unemployment rate of 9.6%.

Of course, with the labor force expanding, consumption has grown as well. Higher levels of disposable income have filtered their way into an increase in home loans for the country as well as a jump in domestic retail consumer spending. Consumer home loans have risen in four of the last five months, and retail spending has expanded eight in the last nine months.

The growth isn’t just domestic, either. In fact, demand for Australia’s raw materials will keep the current boom going. China, the country’s largest export partner by far, maintains bilateral trade that totals close to $80 billion a year.

Both countries are currently discussing a long-term free trade agreement that would build over $125 billion of wealth for Australia over the next two decades. And that’s not all. It is also finalizing agreements with other major partners – South Korea and Japan. Current negotiations have moved into the final stages and may be completed in the next year or so. Successful negotiations would no doubt add to Australian expansion.

And let’s not forget about the Australian dollar’s connection with rising gold prices. In addition to raw material mining, Australia is known for its gold production. It has always ranked in the top five spots of global gold producers.

So it’s no real surprise to learn there is a relatively strong relationship between gold prices and the Australian dollar exchange rates. As gold prices move higher, the Australian dollar strengthens. Statistical studies have shown an approximate 80% positive correlation between the two assets over the last 10 years or so.

That’s a double blessing for Australia. Following the Irish bailout announcement, investors have been seeking refuge in gold commodities once again. Gold futures contracts have bounced back by almost 4% since falling from the record high of over $1,400 a troy ounce back in the beginning of this month. Investors are also changing their money for other currencies.

Given the retracement in gold prices and investor flight from the euro, a bounce back in Australian dollar exchange rates is inevitable in the short-term.

Now, I’m not saying that it’s going to be clear sailing for the Australian dollar in the short-term. There still remains a strong suggestion that officials in Beijing could throw a monkey wrench into the works by radically raising interest rates or shutting down commercial and retail loan facilities. Both would slow trade between the two countries. The last time this happened, November 20, the Australian dollar sold off a bit on concerns of slower trade.

Otherwise, given positive economic growth prospects, strong trade relations and supported asset correlations, the Australian dollar will emerge as the preferred currency investment as Europe wades through its credit crisis.

Richard Lee
for The Daily Reckoning