What the Aussie Dollar Says About Global Risk

Being a true contrarian investor isn’t just about investing in unloved sectors of the market or specific stocks. It’s also about conducting research and discovering indicators that the crowd doesn’t follow — indicators that can help give clues as to the next probable direction of risk assets. I’m always on the lookout for such indicators, and have compiled many of them over my years of trading and investing. [Here’s just one that bares scrutiny. Take a look.] Words: 610

So says Tom Essaye (www.moneyandmarkets.com) in edited excerpts from his original article*.

Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.

Essaye goes on to say, in part:

The crowd, for example, often looks at the U.S. dollar as an indicator of risk sentiment for the markets and, to be sure, it is. Generally, when the dollar goes up, it means investors are seeking the safety of assets like Treasuries and, when it falls, investors are moving to riskier assets such as stocks and commodities. If you are looking to become a savvy contrarian investor, however, there is another “dollar” that can often be a leading indicator of risk appetite across the globe. I’m talking about …

The Aussie – A Pretty Reliable Indicator for Global Risk Appetite

Over the past several years, the Australian dollar has become a pretty reliable indicator for global risk appetite. The reason: Australia’s economy is heavily reliant on exporting its industrial commodities, including iron ore, coal, nickel, and uranium. As a result, the Aussie economy:

• grows when the global economy (and in particular China) is growing and it
• shrinks when global economic activity is declining.

[Why?] Because Australia exports commodities are…[very] closely linked to economic expansion. Their economy usually starts to improve before the rest of the world, as companies and governments begin expansion projects. The opposite happens during times of global contraction.

Like many other nations, Australia’s dollar rallies and falls with the economy. When the economy gets stronger, the Australian dollar rises as markets anticipate rising interest rates in the country to combat inflation — and when the economy stalls the markets anticipate interest rate cuts to stimulate growth.

We can see the predictive power of the Aussie dollar in the chart below. It peaked in early March, way ahead of the stock market and before the commodity markets broke down. Even more recently, it put in a bottom before the stock and commodity markets rallied.

It’s important to note, then, that the Australian dollar is now running into resistance at the downtrend line that dates back to the March top. Contrarian investors know to watch this closely.

• If it breaks through that downtrend, it could be a leading indicator that risk assets like stocks and commodities may be getting ready to turn higher.
• Likewise, if the Australian dollar fails here, it’ll be a sign that the weakness we’ve seen in stocks and commodities is probably going to continue for a while longer.

How to Put This Indicator to Work for You

Now, I’m not saying that the Aussie dollar is the absolute predictor of stock market direction but it is a less followed indicator for risk assets generally, and it is monitored by savvy, contrarian investors….

Conclusion

Being a true contrarian investor involves more than just buying out of favor stocks or sectors. It also takes looking beyond the mass-followed indicators to find ones that are less followed – and that’s where you’ll find the next probable move for stocks and other assets.

*http://www.moneyandmarkets.com/this-leading-indicator-works-for-me-now-put-it-to-work-for-you-49876  (To access the above article please copy the URL and paste it into your browser.)