Aussie dollar giveth, Aussie dollar taketh away
12 October 2009
IN THE past 18 months the Aussie dollar has been as high as US98.5c, as low as 60.09c and is now trading at 90.25c, with reports soon expected of party planners getting enquiries for themed 'Parity Parties'.
In the same time frame US-dollar gold has traded for $US890/oz, down to $US685/oz and back to recent highs at $US1060/oz. The impact of these movements has been that Australian-dollar gold, which was around $A900/oz at the beginning of the period, is now trading at $A1170/oz. USD gold is up $US160/oz while AUD gold is up $A270/oz - not a bad result end to end.
While USD gold is the highest is has been in the period - in fact it is the highest the USD price has ever been - AUD gold is $A400/oz (that’s right, four hundred) off the record highs of $A1570/oz we saw nine months ago. AUD gold is either up 30% or down 20%, it’s all a matter or perspective.
This volatility in AUD gold is unusual but not unprecedented because although the AUD/USD does tend to move in similar cycles to gold, and other commodities, there are times when they get out of sync and as a consequence the AUD gold moves dramatically. In my experience it tends to be at major cycle highs and lows and generally gold moves first; first to rally and first to fall. Not this time: AUD/USD collapsed as the hot money that had been flooding in for years, chasing yield and commodity exposure by proxy, tried to get out in weeks.
If the greenback is going to fall, as the consensus suggests it is, then those who share that view should expect gold and AUD/USD to wend their way higher in unison. Even at today’s exchange rate the USD gold price will need to get to $US1416/oz to better the AUD gold highs we saw at the start of the year. At parity it is $US1570/oz that’s needed and at 1.10 AUD/USD it's $US1727/oz that’s needed to better the AUD gold highs. Just to hold current AUD gold price levels, USD gold must rally about $US110/oz to counter each 10c rise in the AUD/USD.
Think about these numbers for too long and all the combinations and permutations can make you dizzy (well they do me) but a couple of interesting observations come to mind:
- Firstly what good is it to have a view on USD gold prices when your bottom line is driven by the AUD gold prices (assuming you actually have faith in your ability or someone else's to accurately predict the USD gold prices)? If you sell gold in AUD, watch that price. When the legs get out of sink to your advantage, recognise the short-term opportunity.
- If you are bullish gold on a falling USD scenario then surely you need to be an AUD/USD bull as well. Can you be sure which will fair better?
- What if last year's move (AUD/USD down first) was an exception to the rule. With other metals/minerals consolidating and putting support under the AUD in much bigger export volumes than gold does, could gold be the more vulnerable of the two? It wouldn’t be unprecedented to have a period where gold retreats and consolidates and AUD/USD hold or goes higher.
- With a couple of very rare exceptions, Catalpa Resources* being one, it seems no mid-size or major producer in Australia locked in any form of price cover in the window earlier this year where AUD gold prices reached more than twice their previous record. It's one thing to leave your shareholders exposed to price appreciation but surely when significant appreciation comes locking in those kind of AUD operating margins makes sense even if only for a modest percentage and a modest period.
Perhaps the volatile and complex nature of the interrelationship between USD gold and the AUD/USD just makes it easier for AUD gold producers to say it’s all too hard and leave themselves in the hands of the market gods.
Perhaps they are convinced gold can fly in isolation and other commodities and the Aussie dollar will remain earthbound.
Perhaps the ghosts of “market disasters past” play heavily on their minds (or provide another convenient excuse). Ask anyone and they will tell you Pasminco punted the Aussie and got it wrong. That is an over simplification of a much more complex tragedy, in which derivatives trading (you couldn’t call it hedging) was seen as a possible solution to bigger problems no-one wanted to face. Former management wasn’t punting the Aussie, they were punting the company on a metal price recovery that didn’t come for them but did for the next owners.
As that song goes, “Perhaps, perhaps, perhaps”. None is reasonable support for the apparent inaction of local producers. Many who have made tough decisions in the past few years and raised equity, avoided debt and hedging etc are to be applauded. But they should remember that it is perfectly acceptable to change strategy as your circumstances change.
It is not unreasonable to imagine these two markets, USD gold and AUD/USD, will continue to be volatile. Given they appear to be driven largely by the massive liquidity pumped into the global markets they are both remain vulnerable to the short attention span of the market players and the risk of everyone trying to make a quick exit at the same time, should consensus forecasts not be met. If that were to happen it’s not hard to make a case that gold could fall faster and further than the AUD/USD.
No-one exposed to both of these markets should seek to lock in one leg, but it is possible to use options to neutralise an adverse exposure to one or both. More sensibly keep it simple and look at your sensitivity to the AUD gold price. Plug into your numbers the worst-case prices seen in the past 18 months and see what it does to your expected bottom line for the next 12-18 months. If you don’t feel good about what $A900/oz or lower does to your numbers then recognise locking in even a modest percentage of production at current prices can give you a substantial cash flow buffer if things don’t go as expected (hoped!).
Remember when it comes to surviving in a volatile and often hostile price environment it is better to be approximately right than precisely wrong.
*Catalpa Resources is a client of Noah’s Rule.