The Ultimate Contrarian Play: 6 Reasons Why I’m Avoiding the Aussie in the Short-Term

By Evaldo Albuquerque

Yes, you read that right!

You’re probably thinking I’m crazy considering the Aussie dollar has been on a tear for over a year. But there are good reasons to be careful about buying Aussie, especially if you’re trading in the Forex market.

(And to be clear, I am indeed addressing you as a trader about this move.)

Some times it makes perfect sense to follow the crowd in the Forex market. The best current example is the euro. Pretty much everyone hates the euro now, and I would not dare to disagree with that. But following the crowd can sometimes be dangerous – particularly if you’re trading for the short-term.

Contrarian ideas only work when you can find very good reasons to go against the crowd.
While I can’t find many reasons to buy the euro, I can think of at least six good reasons to be skeptical of the Aussie in the short-term.

So let’s get right into it…

1) The Tight Correlation Between the Aussie & Chinese Stocks Has Broken

Everyone knows that the Australian economy is highly dependent on the Chinese economy.

That’s why the Aussie and the Chinese equity market moved together for most of 2009. But this year, the Chinese equity market has been falling, and the Aussie has appreciated by almost 3% against the dollar.

That doesn’t make any sense. Chinese stocks are supposed to go up with the Aussie. But that’s simply not the case right now.

With a -11% return this year, the Shanghai market is by far the worst performing equity market in the world. Traders are clearly concerned that recent government actions to reduce liquidity, fight bubbles and inflation in China will lead to a broad economic slowdown.

Shouldn’t Aussie bulls also be concerned? Let’s also keep in mind that the performance of the stock market is one of the best leading economic indicators.

The Aussie Continues to Rise, While Chinese Stocks Stumble 
2) The RBA Hikes Rates, and the Aussie Didn’t Hit New Highs

This tells me that the all the good stuff that’s going on with the Australian economy is already priced into the Aussie dollar.

There’s no question that the Australian economy has very strong fundamentals. But if you’re trading in the short-term, you need to be aware how much of that great news is already reflected in the current price.

The fact is the Aussie is failing to break through the .94 level for now. So I’m looking elsewhere.

3) Long Positions Have Reached the Same Levels before the Credit Bubble Popped

Everybody loves the Aussie. Because traders are heavily buying the Aussie, a long position in AUD/USD is a trade with a lot of downside risk.

If those long positions start switching sides because of a major risk event, especially involving China, the Aussie will fall really fast. 

4) The Chinese Are Tightening

In an attempt to control inflation and avoid a major bubble in the real estate sector, the Chinese government is starting to implement more rigorous measures to cool the economy.

That will have a negative affect on commodity currencies, including even the ones with strong fundamentals, like the Aussie.

5) Interest Rates Are About to Pause

The Reserve Bank of Australia has made it very clear that they want to bring interest rates to the average rate of 4.5%. They’re almost there. So rate hikes will soon take a break, and it may be a long break!

6) Aussie Will Have More Competition for Capital

Other countries, especially emerging markets, are starting to become more aggressive in terms of hiking rates.

Currencies such as the Brazilian real and the Indian rupee are just a few examples of other higher yield currencies that will attract capital.

If you’re still bullish on the Aussie after reading all these warnings, I completely understand. After all, its economy has continued to outperform that of many other developed nations. And with a sovereign debt position of 14% of GDP, Australia is a role model for fiscal prudence. 

Despite these strong fundamentals, I believe the Aussie’s fate will ultimately depend on Asia. And with China tightening, the Aussie looks very vulnerable to a major correction.

So if you decide to buy the AUD/USD as a short-term play, I would recommend using a very tight stop loss.

In the long-term, if you’re looking for a strong currency to diversify away from the dollar, I would strongly recommend the Aussie. But I would wait for a pullback. Your patience will be rewarded!

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