Vantage FX | Aussie and Gold searching for bottom | 20 May 2013

May 20, 2013

Stocks made fresh all time highs in the US on Friday night with the Dow up 0.79% or 121 points to 15,354, the Nasdaq rose 0.97% and the S&P 500 was 1.00% higher after Consumer Sentiment rose sharply to its highest level in years.

Europe was higher as well – not quite so hot but still rallies across the board with the FTSE up 0.53%, the DAX rose 0.34%, CAC rose 0.55%, Milan rose 0.35% and stocks in Madrid rose 0.46%.

But amongst all the high 5ing as the Dow and S&P push higher the debate about the sustainability of the rally or continues – readers know our view, the economic back drop doesn’t underpin the stock market rally but the Fed’s action certainly do. If you are interested in a deeper understanding of this transmission mechanism we looked at it in this weeks subscriber newsletter which you can sign up for here.

Indeed noted Money Manager Felix Zulauf who is always insightful and a key member of the Barrons roundtable crew put out a piece last week which I think neatly summarises the problems facing the global economy and the debt that economies are carrying. But the reason I include the quote below is because it neatly summarises why Australian households are running their own austerity programs or at least why the rate of growth in debt has slowed and it highlights why the domestic economy will struggle to fill the void of the retreating mining boom.

As long as structural debt and demographic problems remain untackled, I doubt the industrialized world will get back on the growth track of previous decades. Regarding our debt problem, every borrower has a limited capacity to borrow, even governments. When the borrowing begins, it means the borrower can spend (invest or consume) more than his income. In an aggregate sense, economic growth at that time accelerates. Once the borrower reaches his borrowing capacity, he can spend only what he earns or live off his savings (if he has any). At that time, economic growth in an aggregate sense slows down. If his income decelerates at the same time, the spending or the economy slows even more, bringing to the surface all the structural problems of our Ponzi schemes, from our state health systems to our state pension systems and so forth.

Now of course at present the difference – and I think the true source of the Australian economic miracle – is that Australians largely get mandated payrises each year so the tide hasn’t receded.

But the problem with personal and household debt remains as you can see in the chart from the RBA’s monthly chart pack. The RBA rate cuts are having an impact on the percentage of income paid by households on the debt they hold but there has been no material change in the level of debt carried by Australian households.

So Australian households don’t have much fiscal space to borrow and it would be naive to think that they are going to be able to consume much past the rate of growth of income given the limited capacity for debt.

All of which means that there is little option for consumers to fill the gap that is being and is going to be left by the receding tide of the mining boom.

Which means that the turn in the Aussie Dollar has some serious downside risk. The nexus with the stock rally has been broken but it feels like the nexus with anything negative in terms of global growth and indeed domestic growth has been strengthened – as we highlight a while ago before the selloff the worm has turned for the Aussie.

Looking at the daily chart of the AUDUSD above there is little doubt that the Aussie is overdone to the downside at the moment but only as bad as the move to 0.9570 last June and not as aggressively oversold as when it hit around 0.94 in October 2011 or around 0.80 in May 2010. So we would still caution about trying to catch a falling knife and note the market is probably more like 2010 and less like 2011 and 2012 in terms over overall sentiment toward the Aussie Dollar.

0.94 is the key level to watch over the next few weeks and selling rallies is probably going to be the order of the period ahead.

Elsewhere in FX land the Euro made a low just below 1.28 and proof that you should always leave old trendlines on your charts its low was bang on the old uptrend line from 2012 Euro broke through late last year.

Longer term We think Euro is headed back to the 1.21 region because the worm has turned for the US dollar. As Morgan Stanley wrote over the weekend

There has been a significant shift in global currency market dynamics over the course of the past week, driven not only by the JPY, but increasingly by the USD. We have discussed recently the potential change in the status of USD, with the US increasingly being seen as an investment destination and the USD being used less as a funding currency.

This process has continued over the past week, with further strong data from the US leading to a renewed rise in US treasury yields. This rise in US yields now places the USD into the basket of yielding currencies, which suggest further support is likely to
build over the over medium term.

Yes this is the big change in FX markets over the last little while and while Euro rallies will occur and USD sell-offs can result the trend change is clear.

USDJPY traded higher again as well to 103.18 but is off at 1.0282 this morning. We are expecting a reaction from USDJPY lower from this resistance zone but it is elusive at the moment.

On Commodity markets Gold is down at $1361 and only around $40 above the recent lows and the gold aficionados might like to check out this Barrons story via BusinessInsider for a little bit of info/conspiracy about what went on. From where we sit only a break of the $1300/20 zone opens up further substantial downside – but we are watching this zone.

Data

Holidays in Switzerland, Germany and France for Whit day.

In Japan this morning we get the Leading and Coincident Economic indices before Italian Industrial orders and sales and the Chicago Fed index tonight in the US

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