Aussie Dollar exchange implications

The Aussie Dollar – Just keeps getting stronger, but what are the implications? So why is the AUD so strong at the moment?

There are a few fundamental factors that are driving the appreciation in the AUD especially against the US dollar.
Firstly, the continuing strength of the global economy that is providing support for commodity prices. It's no secret that the Australian economy is being fueled by the demand for commodities overseas. What this basically means is that there are a lot of overseas buyers who are paying for our commodities and therefore causing upward pressure in our currency.

Secondly, the strength of the local economy is placing pressure on inflation and therefore the possibility of another interest rate hike. It has been suggested by many economists that the RBA is likely to increase interest rates rather than decrease them this year due to the robust economy causing demand-pull inflation in conjunction with the limited supply of oil causing cost-push inflation.

Finally, the are low expectations of an interest rate rise in the US. The fact of the matter is it's more likely that interest rates will rise here as compared to the US, especially after the relatively low US inflation figures released overnight. Interest rates in Australia are already higher than in the US, therefore institutions and the well-heeled globally will be more willing to invest their money in an Australian bank account than there.

All these factors point to the AUD remaining at higher levels than in the past. Some analysts predict that the AUD should be well supported over the US$0.8000 level for the short to medium-term.

The simple answer to this is that a stronger AUD means that imports become cheaper but exports become dearer. Therefore companies that import are paying less in AUD for their goods. Those that on-sell them without decreasing the sale price enjoy a rising profit margin. On the other hand, those companies that are exporting may find that they will need to lower prices to be able to compete on the global market place, subsequently experiencing decreased margins. This situation was reversed in recent years when the AUD was at much lower levels.

The AUD variation causes different problems for different businesses. One way to try to limit this is by hedging currencies. In theory, this decreases the risk any adverse currency movements have upon the company's balance sheet. Others believe that the cost of hedging your position far out ways the benefit. It would be a good idea to point out that some companies have got their hedging position so wrong in the past that they have actually got into real strife, eg, Pasminco and Sons of Gwalia. The former became Zinifex and the latter went under.

Companies that are not benefiting from the rise in the AUD are ones who earn a large proportion of their income is USD. The reason is simple; the weakness in the currency as compared to the AUD means that profit earned over there is not worth as much. Furthermore, company forecast will not be met as AUD keeps appreciating against the USD. Companies that have operations in the US include Brambles (BXB), Resmed (RMD), CSL, Rinker Group (RIN), James Hardie (JHX), Boral (BLD), Aristocrat Leisure (ALL), Lend Lease corporation (LLC), Billabong (BBG) and Newscorp (NWS) just to name a few. These companies have to find ways to minimise the effect of the rising AUD, generally through hedging practices. Each company will have a section in their company's annual report highlighting how much of their future income has been hedged.

Some of the miners have also been hit recently with our currency appreciation somewhat offsetting the appreciation in commodity prices. These companies include Zinifex (ZFX) and Newcrest Mining (NCM). It was reported recently that the profit of NCM this financial year would actually decrease substantially, over 80%. Admittedly production problems have also contributed to analysts forecasts as well.

Alternatively, companies that are net importers have benefited greatly, like Harvey Norman (HVN). It is recommended that you don't place your investment decision solely on a companies exposure to predicted currency prices. A better strategy is to find companies with good business models first, then assess their exposure to currency movements. As stated above the annual report will indicate a company's hedging strategy.