Undervalued Down Under?

Australian Flag
Australian Flag

Don't look now, but this strategist says the Australian dollar is looking awfully cheap.

Let's see: worries about China, pressure from commodities — you'd think all the negative talk about the Australian dollar would be driving it down. Steven Englander, head of G10 foreign exchange strategy at Citigroup, says it is. Too much, in fact.

The Australian dollar's "usual drivers suggest that it is significantly undervalued," he wrote in a note to clients. "In fact, relative to our equation for AUD, the degree of undervaluation is as large as it has been over the last 40 months."

Englander and his team looked at a series of variables to determine where they think the Aussie should trade, including interest rates in the U.S. and Australia, the difference between those rates, commodity prices, volatility, and futures on China's currency.

They have also looked at how far the Aussie's value has moved from the value those variables predict — the residuals. Right now, Englander says, the gap between predicted and actual value is large, and "whenever residuals have been this big in recent years, it signaled a subsequent AUD rise," perhaps because investors realize they have been overly bearish.

Take a look at the chart above, notice what happened in April 2009, June 2010, and March 2011 — and get busy.



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