The Aussie dollar bears have got it right.
The currency is over-valued, the economy is slowing, and the resources boom is over.
Practically everything they say stands up as an argument…except for one thing: the Aussie dollar isn’t going down.
So here’s an idea for you: although the case for the Aussie dollar going down isn’t playing out in the currency market, it is in the stock market.
That might sound odd at first, but it’s the task of today’s Money Weekend is to see if this holds up – and how you can profit from it.
Any traders who were short the Aussie dollar might’ve breathed a sigh of relief when the Reserve Bank of Australia (RBA) announced a cut to Aussie interest rates this week. Technically this should weaken the case for holding Aussie dollars and assets.
But it didn’t.
Short traders’ relief wouldn’t have lasted long, because the Aussie dollar didn’t fall. In fact, it started going up.
The general view seems to be that the RBA was trying to knock a bit of stuffing out of the Aussie dollar more than anything. If it was, that’s too bad, because the Aussie is now closing in on US$1.05.
The Australian Financial Review explained it this way on Thursday:
‘Currency experts have been left puzzled by relentless investor interest in the Australian dollar in spite of cuts to the national cash rate, China’s slowdown, and falling prices for key commodities.’
But if we’re learning one thing about the Aussie dollar right now, it’s that money coming into Australia is more powerful than the terms of trade.
The Chinese economy has slowed, iron ore and coal prices are off their highs and interest rates are falling. All this has been going on for over a year. But instead of looking to the dollar, maybe we should look at the stock market.
Now, the stock market and the economy are two different things. (For example, a country can have fabulous GDP growth but stocks go nowhere, or even down.) But one investing adage is that the stock market tries to predict changes in the economy. And another adage says that when investors are fearful, they dump the riskier stocks first.
And that’s exactly what investors have done this year. See for yourself with this chart of the ASX Small Ordinaries Index…
Let’s face it: unless you feel optimistic about the future, smaller, riskier companies are less likely to be on your radar.
But even if you think the world’s second biggest economy (China) is slowing, and taking key commodity prices with it, it’s still hard to see Aussie investors dumping Aussie dollar assets and buying foreign markets instead.
So we’ll take a guess and say Aussie investors will stay with what they know. Even so, over the past year, investors have bailed out of the tiny end of the market and moved into the perceived safety of blue-chip stocks (see the performance of the Aussie banks and Telstra this year).
You can argue that the gap between the big end of town and small-cap stocks is a fear measure. Aussie investors have dumped perceived riskier shares because of structural problems within China surfacing and causing a dreaded slowdown.
Here’s a repeat of a chart we showed last week.
But that trend could be about to change…
Diggers & Drillers editor Dr. Alex Cowie has written in Money Morning about the trouble faced by mining companies trying to get financing. For Diggers & Drillers, this has meant switching focus to companies that already have cash on the books.
But there’s more to small-cap stocks than junior miners. There’s technology, health and retail stocks that trade at the small end of the market. Some of these businesses aren’t even remotely correlated to China or commodities.
That means there’s a chance to pick up small-cap stocks trading on a ‘fear’ discount.
All this goes some way to explaining Kris Sayce’s (our small-cap specialist here at Port Phillip Publishing) position that small cap stocks have suffered a silent crash. The main index doesn’t show it because banks and big resource stocks drive the ASX/200.
There are some small-caps that have already delivered tidy gains to investors. For example, Breville Goup Limited (ASX: BRG), Credit Corp Group (ASX: CCP) and Thorn Group Limited (ASX: TGA) are all up at least 20% since the mid-point of the year. Sirtex Medical (ASX: SRX) is up over 100%.
This gives you an idea of the lucrative gains small-cap stocks offer. But according to Kris, there are still plenty of other small-cap stocks left on the bargain counter.
Here’s what Kris told subscribers to Scoops Lane (the free weekly e-letter we send to anyone who subscribes to a paid Port Phillip Publishing service) this week on why he in particular is so bullish on certain small-cap stocks:
‘In many cases those stocks are there for a reason – they are bad businesses. But there’s also a bunch of stocks that don’t deserve to be there. They’re beaten-down stocks that are simply going through a rough patch or they’re stocks that have a great new discovery, product or service that hasn’t yet convinced the market they’ll ever be profitable. Investing in these stocks is risky, and it won’t always pay off.‘But when it does pay off the reward can be huge. The trick is to try and identify the winners and avoid the losers.’
We don’t know where the Aussie dollar is headed. But we do know the first part of successful investing is finding something that’s trading below its potential value. If Kris is right, there’s plenty of value among small-cap stocks. To us, that means looking at the small-caps first and blue chips second.
Callum Newman
Editor, Money Weekend
The Most Important Story this Week
The fact that the Reserve Bank cut the interest rate this week spells bad news for savers and anyone relying on fixed income. If you can’t get a big enough return on term deposits, how can you earn more money? You could consider Kris Sayce’s strategy to beat the central bankers – see what he says in How to Make Cash-Like Returns Using Shares
Highlights in Money Morning This Week…
Murray Dawes on How Long Can the Market Ignore These ‘Warning Signs’?: ‘Watching markets levitate higher as economic data continues to slide has me scratching my head. Is money printing really the only thing you need to make markets go up? Do fundamentals no longer matter at all? How long can the charade go on?’
Satyajit Das on The Golden Age Redux: ‘As the Global Financial Crisis continues and the cure of easy money proves as dangerous as the disease, the gold price has increased from around $250 per troy ounce in 2001 to a peak of over $1,900 in 2011. It now trades at around $1,750 per ounce. As poet John Milton wrote, ‘Time will run back and fetch the age of gold.”
Merryn Somerset-Webb on Is it Time to Ditch Blue Chip Stocks for Small Caps?: ‘Older readers will remember a time when it was commonly accepted that smaller companies always outperform big companies and that smaller companies should therefore trade at a good premium to big companies. ‘Elephants don’t gallop’, people used to say): it’s easier for a tiny company to double its size – and your money – than for a big one.’
Dr. Alex Cowie on Is There Any Good News to Come from the US Debt Crisis?: ‘Gold prices have been closely correlated to the US debt level, and where the debt ceiling goes, the debt level follows. Silver moves with US debt levels as well, though not quite as closely as gold. This is certainly not the only reason to own precious metals, but could be a strong short term driver.’
From the Port Phillip Publishing Library
Australian Small-Cap Investigator:
Five Simple Steps to Picking Winning Small-Cap Stocks
How the Strong Aussie Dollar is Hiding Small-Cap Opportunities