Petrol, the Dollar and the Yuan

I filled the car up last week and got quite a shock.

The bill came to $125.

I don’t ever remember paying more for a tank of petrol.

The culprit? I’m guessing a falling Aussie dollar has a bit to do with it.

As you know, when the Aussie dollar falls, the stuff we import increases in price (other things being equal, of course).

As you can see in the chart below, the Aussie dollar recently broke below 70 US cents. It’s trading at the lowest level since January 2016.

Australian Dollar / US Dollar - AUDUSD (FX) - 1 Day Bar Chart - USD 16-05-19

Source: Optuma

[Click to open in a new window]

But back in January 2016, the world was in the midst of a major growth scare. Commodity prices — including coal and iron ore — were in the toilet. It ‘made sense’ that the currency was under pressure.

But now?

Free Report: ‘The Top Three Gold Stocks on the ASX’

Commodity prices are strong

Commodity prices (especially coal and iron ore) are strong. Just look at the share prices of BHP and Rio. They’re at multi year highs. So it’s very unusual to see the dollar so weak.

What’s going on?

As I’ve said in the past, the Aussie dollar is a great barometer for the health, or otherwise, of the global economy. The chart above tells you that global economic growth peaked in early 2018.

Central banks, as they nearly always do, continued to raise rates after the peak. This brought about a sharp equity market contraction in late 2018, as liquidity began to dry up.

A quick about face from central banks quickly solved that particular problem, but it hasn’t done much for the global economic growth story. The continuing weakness in the Aussie dollar tells you that.

Even the big injection of stimulus from China at the start of the year couldn’t break the downward trend of the dollar. The currency rallied off support at 70 US cents, but peaked at 73 US cents in February before turning down again.

Now, there are signs that China’s economy is slowing…again. As the Wall Street Journal reports:

BEIJING—China says domestic spending by its own citizens will minimize the economic damage of its trade fight with the U.S. Yet demand from consumers and factories is looking shaky.

Even before trade tensions ratcheted up in the past week or so, China was facing headwinds as it worked to expand its middle class and make the world’s No. 2 economy more consumer-driven. Economic figures released Wednesday and in recent weeks show slowing activity by consumers, as well as factories, and add to doubts about China’s domestic playbook for the protracted trade dispute. 

A 7.2% rise in retail sales last month from April 2018 marked a substantial 1.5-percentage-point reduction from the year-over-year rate in March. April’s pace was last seen when China ordered people to stay home during the SARS pneumonia more than a decade and a half ago. Some economists had predicted April sales would grow 8.8%. Now they expect the government to expand the stimulus measures employed last year and at the start of this one.

So this bad news is good news? Slower growth means more stimulus, which mean higher share prices?

Maybe. Let’s see what the Chinese stock market has to say about that. It’s one of the best barometers of liquidity in the Chinese economy that I know of. When liquidity is abundant and confidence is high, Chinese stocks do well.

The opposite is also true. Recently, reflecting the renewed slowing of Chinese growth, the Shanghai Composite Index broke back below support, as you can see in the chart below.

Shanghai COmposite Index - SSEC (WI) 16-05-19

Source: Optuma

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On a positive note, it bounced off the 100-day moving average (red line) but the major test will be when it comes to retest that resistance area (around the green line) in the weeks ahead.

Given the concern over the fallout from the renewed trade war, it’s hard to see Chinese stocks sustaining a recovery. Especially when you look at the yuan/US dollar exchange rate (see chart below). Clearly, foreign capital is fleeing mainland China…

Chinese Renminbi Yuan / US Dollar - CNYUSD (FX) - 1 Day Bar Chart - USD 16-05-19

Source: Optuma

[Click to open in a new window]

This raises the stakes for Australia in the months ahead.

The fact that iron ore and coal prices remain strong (in the case of iron ore, thanks the global supply issues) is a blessing for Australia right now. If the Chinese economy does roll over and sends these two important commodities lower in the months to come, expect the Aussie dollar to continue falling.

And if the Labor/greens get a strong result on Saturday, expect the fall to gather pace. I can’t see how global capital will want to invest in this country on the same terms under a Labor government.

The dollar will probably continue falling into the mid-60s, in order to make our assets relatively cheaper in the eyes of foreign investors.

Meanwhile, our stock market continues to hold up, not far from multi-year highs. The ASX 200 is still in an upward trend and therefore bullish. But there is a risk that you’ve already seen a short term peak, and the market is in the process of topping out.

More on that tomorrow…


Greg Canavan,
Editor, The Rum Rebellion

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