Morgan Stanley’s is recommending investors short the Australian Dollar vs. both the U.S. dollar and Singaporean dollar. Their main concerns are that the government’s new ‘resource super profits tax’ on mining companies, such as BHP (BHP), will destroy the mining industry’s valuations and create a headwind for Australian economic growth.
The large mining companies, such as Rio Tinto and BHP, have already noted that this change alters their expected investment profile; it has also put some new projects in doubt. Morgan Stanley’s Australian resources equity analysts estimate that the potential reduction in company valuations may be up to 37% (“Valuation downside on new royalty taxes”, Australia Nonferrous Metals and Mining, April 28, 2010).
The mining sector has made up a significant part of Australia’s growth in recent years (see Exhibit 1), protecting it somewhat from the global financial and economic turmoil. This has enabled Australia’s outperformance in terms of GDP growth, interest rates and ultimately the AUD.
The implementation of this tax, assuming that it does decrease corporate activity, mining investment projects and potentially mining volumes and exports, counteracts high commodity prices in terms of the sector’s benefit to the currency.
Basically Australia could be choking off the very thing that saved them during the recent economic downturn. Talk about scoring an own goal.
In addition, Australia’s rate-hike cycle, which is already well under way after six rate increases from the central bank, is likely to start biting into the Australian economy.
Our portfolio is also short AUD, one of our highest-conviction positions. Increasingly it looks like the six RBA rate hikes are impacting the economy, and this week we again saw weaker home loan data. We would also note that the Australian dollar is extremely overvalued according to our valuation models (35% versus US dollar), having benefited from the huge stimulus given to the global economy over the last few years, which is reflected in the price of the AUD.
With the Federal Reserve likely to start draining liquidity in the summer and with growing evidence over the past week that the Chinese economy is perhaps starting to overheat, we believe that the AUD is vulnerable to a change in sentiment about the likelihood of a soft landing in China. We like being short AUD against SGD and USD.
Australia may be inadvertently hanging itself here… basically the Australian economy weathered the storm better than most economies thanks to its resource industry which continued to fuel China’s robust growth. Due to this outperformance, Australia was forced/able to hike interest rates well before everyone else. Yet now… they are killing the driver of economic performance while at the same time being forced to deal with the higher interest rates they thought they could bare thanks to the mining industry driving outperformance.
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