Investment markets consolidated recent gains in February with the All-Ordinaries index closing the month 1.0% higher at 6,940.6 points. The Australian Dollar gained 0.8%, with 1 Australian Dollar buying 77.1 US cents.
As expected, the Reserve Bank of Australia (RBA) held the official Cash Rate at 0.10% per annum in February. No change is expected to the Cash Rate when the RBA board meets again on Tuesday.
Global share markets were higher in the month of February, with the United States Dow Jones index gaining by 3.2%, the London FTSE gaining by 1.2%, the Japan Nikkei 225 gaining by 4.7% and the Hong Kong Hang Seng Index gaining by 2.5% for the month.
The rapid rise in the Australian Dollar over recent months has pull-back returns of international shares held in client portfolios (when adjusted to Australian Dollars). In my view, the strength of the Australian Dollar comes down to demand for Australia’s largest export, iron ore.
The left-hand chart below shows the strength in the Australian Dollar over the last year and the right-hand chart below shows the strength in the iron ore price over the same period.
Prices for iron ore jumped to above $175 per tonne in the last week of February, a level not seen since October of 2011, amid continued robust demand from China and persistent doubts about Brazilian shipments from Vale, the world’s top producer.
The correlation between the Australian Dollar and iron ore prices is not a new revelation. The left-hand chart below shows the strength in the Australian Dollar over the 10-years and the right-hand chart below shows the strength in the iron ore price over the same period.
In context of the above, when forming a view of the Australian Dollar over the medium term, strong consideration must be given to the price of iron ore.
I would note that the world’s largest producer of iron ore, Vale, has plans to significantly increase their production over the next 5-years. If these plans are implemented without any significant increase in demand for iron ore, then I would expect the price of iron ore to decrease – and by extension there would be downward pressure on the Australian Dollar.
It is for the above reasons, that my 5-year forecast for the Australian Dollar is some 15 to 20% below its current trading level.
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This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.