Even after a 14.2 percent decline in 2013 the Australian dollar remains well above its historical average, despite record-low interest rates, lower commodity prices and a slowdown in mining investment.

After an initial surge after the New Year the aussie continued its slide, hitting a three-and-a-half-year low of USD0.8683 on Jan. 24. That’s 21 percent its all-time closing high of USD1.0993 set July 29, 2011.

Since then, however, the aussie has regained some footing, rising 4 percent to USD0.9034 as of the close of trading on Feb. 14.

The International Monetary Fund (IMF), in an otherwise positive country report on Australia released on Feb. 12, concluded that, in order for broader-based growth to take hold in the aftermath of the mining boom, the aussie is 5-10 percent above the level predicted by Australia-specific factors from a medium-term perspective.”

This implies a value range of USD0.80 to USD0.85 for the aussie.

The IMF notes that the aussie has provided a safe harbor over the past few years, with strength rooted in “substantial capital inflows to fund the mining sector investment, the gap between domestic and foreign interest rates, and portfolio allocation towards Australian dollar assets by foreign institutional investors.”

The most substantial threat, the one most forecasters who expect the aussie to decline over the course of 2014 identify, is the continuing “taper” by the US Federal Reserve of its monthly bond purchase.

The IMF concludes that a further decline for the Australian dollar will “support the transition of the economy towards more balanced growth.”

The US economy is looking very good relative to the rest of the world, including Australia, right now. US gross domestic product (GDP) grew by an annualized 3.2 percent during the fourth quarter of 2013, accelerating from 0.1 percent during the fourth quarter of 2012.

According to the Australian Bureau of Statistics (ABS), Australian GDP expanded by 2.3 percent during the third quarter of 2013. Data for the fourth quarter will be released on March 5, 2014.

And the “rate differential” has narrowed, with the Reserve Bank of Australia (RBA) cutting its benchmark to an all-time-low 2.5 percent compared to the Fed’s 0.25 percent/“zero bound” target. The withdrawal by the Fed of extraordinary monetary stimulus has given further impetus to the buck versus global peers.

But the RBA’s views on the value and direction of the aussie differs from those of the intergovernmental agency. The Australian central bank omitted its reference to the aussie being “uncomfortably high” in its Feb. 4, 2014, rate decision, when the currency was sitting at USD0.88. That suggests the RBA is comfortable with the present level, which is in fact in the neighborhood of the aussie’s 10-year average of USD0.87.

The IMF’s adoption of a long-run average range neglects the reality that there is no long-run average situation for either the global economy or Australia’s relative position within it.

And it’s a difficult task to define a value for a factor that has different consequences for different parts of an economy.

Of course there are parts of the Australian economy that would benefit from a currency in the range of USD0.80 to USD0.85. But there are also parts that wouldn’t benefit, as the lower dollar brings with it risks of inflation. And the price to pay for a weaker aussie could be higher interest rates for the whole economy.

Indeed, the RBA recently noted that inflation in Australia has ticked to the upper end of its target band of 2 percent to 3 percent from the middle of that band in the span of a single quarter, a period that coincided with sharp depreciation for the Australian dollar.

Australia does seem to be emerging from the relative torpor of late 2012 and 2013. This week the RBA boosted its economic growth as well as its inflation forecasts and reiterated its shift to a neutral policy stance.

“Over the past few months, there have been further signs that very stimulatory monetary policy is working to support economic activity,” the RBA said in its quarterly monetary policy statement. “The board’s view is that a period of stability in the policy rate is likely.”

The central bank projected core inflation of 3 percent in the year ending June 30, 2014, half a point higher than its previous forecast, and 2.25 percent to 3.25 percent through December 2014, a quarter-point increase.

GDP is forecast to expand by 2.75 percent in the year to June 30 and 2.25 percent to 3.25 through December 31, “primarily owing to the lower exchange rate, which is expected to boost exports and restrain imports.” These forecasts are up from November’s estimates of 2.5 percent and 2 percent to 3 percent, respectively.

It appears as though the RBA’s rate-cut medicine has had the desired impact, with home prices rising and increased demand spurring a pickup in approvals for residential construction. Loan approvals are also at high levels.

The RBA maintained a subdued outlook for a labor market that will “exert downward pressure” on wages and inflation.

And though the pullback in mining investment has been much ballyhooed, the RBA noted that although “bank liaison suggests that the peak in mining investment has passed, the expectations component of the ABS capital expenditure survey, which tends to be relatively imprecise guide to firms’ realized spending, continues to point to some growth in mining investment in 2013-14.”

The RBA expects China, Australia’s biggest trading partner, to grow by about 7.5 percent in 2014, similar to 2013. And it expects growth for Australia’s other major trading partners to average 4.5 percent, a little higher than in 2013.

A key swing factor is state and federal spending.

Governments have tightened their belts, to the extent that “fiscal consolidation foreshadowed by state and federal governments implies the weakest period of growth in public demand for at least 50 years.” But an extended period of below-trend growth could pull governments out of their foxholes.

The IMF’s most recent Currency Composition of Official Foreign Exchange Reserves (COFER) report, updated Dec. 31, 2013, revealed that holdings of Australian dollars rose nearly by 0.7 percent during the third quarter to USD102.3 billion as of Sept. 30, 2013, compared to USD101.6 billion as of June 30, 2013.

Aussie holdings among 145 reporting countries have risen by 14.1 percent since the fourth quarter of 2012.

Australia still hasn’t suffered a recession in more than two decades. Government finances are relatively healthy, and it remains well positioned to take advantage of the recovery in the global economy.

These factors haven’t gone unnoticed by long-term-focused investors, including global central banks.

Portfolio Update

We’re off to a solid start in 2014, in terms of market performance as well as with financial and operating results for the AE Portfolio.

From Dec. 31, 2013, through Feb. 12, 2014, the 15 Conservative Holdings posted an average total return in US dollar terms of 1.4 percent. Our 14 Aggressive Holdings, meanwhile, posted an average US dollar total return of 1.6 percent.

The S&P/Australian Securities Exchange 200 Index was up 0.4 percent for this timeframe. The S&P 500 Index was down 1.3 percent, while the MSCI World Index was off by 1.2percent.

iShares MSCI Australia Index Fund (NYSE: EWA), a decent benchmark for the Conservative Holdings, posted a total return of 0.7 percent for the relevant time period. IQ Australia Small Cap ETF (NYSE: KROO), a reasonable analog for the Aggressive Holdings, was up 1.2 percent.

As of Feb. 12 the Australian dollar had appreciated by 1.2 percent versus the US dollar in 2014 after a slide of 14.2 percent during 2013.

And, as we detail below and in this month’s Sector Spotlights and the In Focus feature, numbers reported by our Holdings suggest a Portfolio stocked, in the main, with high-quality businesses.

This month’s highlight as to be the 3.6 percent dividend boost announced by charter Portfolio Holding Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY), the first increase for Australia’s dominant telecom services provider in nine years.

Portfolio Update has more on Telstra, plus financial and operating numbers from five other Holdings as well as a couple interesting developments for AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY) and recent Portfolio addition Crown Resorts Ltd (ASX: CWN, OTC: CWLDF, ADR: CWLDY).

In Focus

Iron is indispensable to modern civilization, a thesis demonstrated in real time via the massive infrastructure build-out still underway in China. And iron ore–due to Australia’s proximity to the Middle Kingdom as well as its abundant reserves–is now the Land Down Under’s key export commodity.

The certainty of China’s rampant growth during the first years of the 21st century has given way to questions about the shape of future demand, as policymakers in what’s now the world’s second-largest economy attempt to engineer a transition from a an investment-led to a consumption-led growth model.

This will eventually lead to reduced demand for commodities such as iron ore, as infrastructure and home-building taper and emphasis shifts to soft commodities that help satisfy maturing appetites and the provision of services such as education, money management and health care.

Of course there are a great many uncertainties at work here, chief among them China’s growth rate and the speed of its economic transition. But there’s little doubt that the direction of the iron ore market will have a significant impact on Australia.

In Focus takes a look at iron ore producers in the AE How They Rate coverage universe and how they may or may not fit within investors’ portfolios.

Sector Spotlight

The market didn’t much appreciate CSL Ltd’s (ASX: CSL, OTC: CMXHF, ADR: CMXHY) fiscal 2014 first-half financial and operating results, sending the Parkville, Victoria, Australia-based biopharmaceutical’s share price sliding by 4.8 percent on the Australian Securities Exchange (ASX) from a AUD69.86 close on Feb. 11, 2014, to AUD66.50 by the close of trading on Feb. 13.

The longtime Conservative Holding, which was one of the first two Australia-based companies we picked in October 2011 to join the “Eight Income Wonders from Down Under” that comprised the AE Portfolio upon the advisory’s September 2011 debut, missed the consensus estimate among analysts for revenue growth and also trimmed its earnings growth forecast, establishing a rationale for the stock’s steepest slide in nearly six months.

The short-term selloff also gives us an opportunity for new money to establish positions in a solid global health care company with an outstanding record of raising its dividend, buying back shares and building wealth for its owners.

We have more on CSL in this month’s first Sector Spotlight.

AE Portfolio Aggressive Holding Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY) is an increasingly valuable oil and gas property, with significant, identifiable and realistic production and revenue upside.

The company’s short-, medium- and long-term potential is well known to bigger players in the global exploration and production space. And a specific event related to financing activity by one of the company’s major shareholders could drive immediate upside for the stock.

At the same time, this investor is working to ensure that any exit in the short term is driven by an offer that reflects the substantial long-term value embedded in Oil Search.

This month’s second Sector Spotlight focuses on Oil Search.

News & Notes

Resources Fuel Record Trade: Although Australia’s economy continues to struggle, resource exports are a considerable bright spot, notes AE Associate Editor Ari Charney.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced reduced dividends during fiscal 2014 first-half earnings reporting season Down Under as well as those that have lowered earnings guidance in recent weeks.

The ADR List: Many Australia-based companies that list on the home Australian Securities Exchange (ASX) are also listed on the New York Stock Exchange (NYSE) or over-the-counter markets as “sponsored” or “unsponsored” American Depositary Receipts (ADR).

Here’s a list of those companies, along with an explanation of what these ADRs represent.

How They Rate

How They Rate includes 113 individual companies and four funds organized according to the following sectors/industries:

• Basic Materials
• Consumer Goods
• Consumer Services
• Financials, including A-REITs
• Health Care
• Industrials
• Oil & Gas
• Technology
• Telecommunications
• Utilities
• Funds

We provide updated commentary with every issue, financial data upon release by the company, and dividend dates of interest on a regular basis. The AE Safety Rating is based on financial criteria that impact the ability to sustain and grow dividends, including the amount of cash payable to shareholders relative to funds set aside to grow the business. We also consider the impact of companies’ debt burdens on their ability to fund dividends. And certain sectors and/or industries are more suited to paying dividends over the long term than others; we acknowledge this in the AE Safety Rating System as well. We update buy-under targets as warranted by operational developments and dividend growth.

In Closing

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David Dittman
Editor, Australian Edge

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