Smart Investor: Acid Test, December 2010

Smart Investor, December 2010

Acid Test

Is a soaring Aussie dollar good news?

1. Do you have many overseas investments? Yes/No

A rising Australian dollar is great news for your overseas holidays, but it’s not so good if you have many investments outside Australia. If you have a mutual fund investing in the US, for example, and that fund makes 10% on its investments, that’s not much use if the Aussie dollar appreciates by 10% against the greenback – one cancels out the other (and if your fund instead makes a 10% loss, you’ve got a double hit: the fund and the currency).

2. Is your superannuation in an aggressive option? Yes/No

The more aggressive a superannuation option you are in, the more likely it is that it has a significant allocation to overseas shares, as well as bonds and possibly property. Some super funds hedge out the impact of currency movements (see below), but many do not, particularly for their equities component. Conservative or balanced options tend to have a greater allocation towards familiar assets at home, both debt and equity.

3. Are you invested in gold or other precious metals? Yes/No

Gold has been one of the best performing assets in the world in the last 12 months, but you might not have noticed if you invested from Australia. That’s because gold prices are quoted in US dollars. In the year to August 31 gold was up 30.62% in US dollar terms, but in Aussie dollars it was a (still impressive) 20.36%. In short, as the Aussie dollar rises, it neutralises any gains in gold and other metals quoted in dollars – silver, palladium and platinum, for example. That said, if you think the A$ can’t go any higher and has to fall, then commodities are a good investment now because any fall in the Aussie will be to your advantage.

4. Do you own many domestic stocks that are heavy exporters, such as resource stocks? Yes/No

It’s hard to draw clear conclusions on the impact of a strong currency on the domestic share market, but logically exporters become less competitive, and so make less money. Resource stocks are among our biggest exporters, although set against that, the demand for resources from Asia is so high it supersedes most currency movements.

5. Do you take foreign holidays? Yes/No

This is the good bit. It has been 28 years since the Aussie dollar was last worth more than a US dollar. If you have long had a hankering for a trip to California – or to any place where the currency is linked to the US dollar, such as Hong Kong, China or Dubai – now is the time. The Aussie is also very strong against the pound and euro now, so Europe’s more affordable too.

6. Do you own domestic small cap stocks? Yes/No

AMP’s Shane Oliver points out: “Periods of A$ strength are normally positive for the relative performance of small caps because they are cyclical, have less offshore exposure and benefit more from lower import costs.”

7. Do you own domestic shares that make a lot of imports? Yes/No

Since imports get cheaper with a strong Australian dollar, companies that rely on them get a free kick from the stronger currency. These are rather more rare than Australian companies that export a lot, but they include airlines – who benefit from a relatively cheaper cost of fuel, since most fuel contracts are quoted in US dollars – and retailers.

8. Do you buy imported goods? Yes/No

This is the most straightforward impact of currency appreciation: foreign goods get cheaper. The most obvious one is petrol for your car – although somehow the oil majors have managed to keep prices high historically despite movements in currencies. Cars themselves, too, should get cheaper. We import dozens of things here: most electronic gizmos, including computers; lots of clothes; even some foods.

9. Do you have a firm view on where the currency is going next? Yes/No

Whether you believe the currency is going up or down, if you are correct in your assumption, you can make money from it. Contracts for difference (CFD) providers have made it easier than ever to play your view on the currency. Just be aware that currency movements are notoriously difficult to predict accurately.

10. Are your overseas funds hedged? Yes/No

Many overseas funds, whether in debt or equity, offer hedged versions. These remove the currency from the picture, often by using derivatives, so that you can invest purely based on your view on, say, emerging markets or US shares, without worrying what the currency is going to do. If you’re hedged, then the rising A$ hasn’t hurt your overseas investments at all – meaning you have probably benefited from the share price rebound in many markets since 2008.

THE VERDICT:

Mostly yes (questions 1-4) and no (questions 5-10): A rising Aussie dollar might give you a glint of national pride but it’s bad news for your portfolios.

Mostly yes (questions 5-10) and no (1-4): Bring it on! The Aussie dollar’s rise is to your advantage. Now, about that holiday to San Francisco…