The Bear Case for the Aussie Dollar: a 30% Drop

The Aussie dollar jumped on Thursday, rising one percent versus the U.S. dollar on strong jobs data, but one strategist is calling for a sharp correction - forecasting the currency will fall as low as 70 cents against the greenback over the longer-term.

Australian Notes - Mixed
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Australian Notes - Mixed

Paul Gambles, managing partner at MBMG believes the greatest threat to the currency doesn’t stem from falling resource demand from China, but instead from the country’s domestic economy, particularly the “overvalued” housing market.

“We've got a domestic economy that's performing absolutely terribly…We think that Australian dollar along with perhaps the Aussie banks and Aussie property are maybe the greatest shorting opportunity that we're going to see for a long time to come,” Gambles told CNBC.

Home prices in Australia have seen a multi-year boom but last year prices fell 4.8 percent according to the Bureau of Statistics’ home price index.

A meltdown of the property market would be detrimental for the Australian dollar because net capital inflows into real estate have contributed to the strength of the currency in the recent years, according to some experts.

In the first nine months of 2011, for example, foreign investors accounted for a third of commercial property transactions in Australia, the highest share in nearly two decades, according to property firm CB Richard Ellis.

Gambles believes the real estate market is greatly overvalued, and according to calculations by The Economist, prices are 38 percent above where they should be based on the ratio of price-to-incomes and price-to-rents.

Falling property prices and higher mortgage delinquencies have sparked concerns over the health of the sector. Ratings agency Fitch revealed the national arrears rate rose from 1.52 percent to 1.57 percent for the fourth quarter of 2011. But the Reserve Bank of Australia said on Wednesday that it doesn’t foresee a meltdown in the housing market.

Sandy Jadeja, Chief Technical Analyst at City Index, agrees with Gambles’ bearish call for the commodity currency to hit 70 cents over the longer-term.

According to him, the currency could hit parity versus the dollar in the short-term before falling to 79 cents. If it breaks below that, Jadeja thinks 70 cents is possible.

But Ray Attrill, North American head of FX strategy for BNP Paribas disagrees with the bearish forecasts for the currency and the housing market.

“The housing market has been talked about for many, many years as a bubble that's waiting to burst. For the past couple of years, we've seen house prices basically flatten in Australia but with wages still going up.”

Attrill believes that if the property market does fall, the Australian government has the ability to step in and help. Australia’s budget deficit of 3.4 percent of gross domestic product (GDP), is much lower than that of other developed countries.

Plus, Attrill believes the Reserve Bank of Australia could cut interest rates to stimulate the economy. The RBA raised interest rates by 1.75 percentage points between 2009 and 2011 after the global financial crisis. Investors are now forecasting the central bank will reverse some of those rate hikes.

“We've got almost the best part of 100 basis points of rate cuts in the RBA priced into the money market curve,” Attrill said. He believes fair value for the Aussie is at 1.05 against the U.S. dollar.

Kathy Lien, director of currency research at online trader GFT agrees that losses for the currency will be limited this year. She says interest rate differentials and expectations for further policy easing out of China and the ECB will continue to provide support.

“I'm looking for a move below parity, maybe around the 0.99 region,” she said.