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8/6/2019 Strategic AUD Views - Mar 2011 Edited
1/18
Nomura International plc
See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures
Strategic Currency ViewsFX Research and Strategy
The Australian Dollar: Remarkably resilient
AUD/USD forecast: We forecast AUD/USD to hold around parity in 2011 and
2012. We are tactically bearish AUD as China starts its tightening policy.
Country-specific factors: The market is pricing no RBA hikes this year. The
recent natural disasters in Australia mean the market now expects the hikes to be
delayed. We forecast negative growth for Q1 as a result of these floods, but growth
should pick up in the following quarters. We also think that, as China intensifies its
tightening cycle, demand for Australian exports could wane.
Global USD direction: We remain constructive USD, especially for the next few
months.
Global risk factors: We expect the risk environment to remain mildly risk-seeking
over the next few months, but we view the risk-reward on risky assets as limited atpresent.
Volatility: The volatility curve is slightly higher than one-month ago suggesting a
decline in market risk sentiment at present.
AUD trading views
We are currently flat AUD.
Economic outlook
We expect the Australian economy to have negativegrowth in Q1 2011, because of the recent floods, but
expect a turnaround in Q2. We forecast GDP to be
2.8% for 2011.
Inflationary pressures are expected to remain. Thefloods and cyclone are expected to provide upward
pressure, and we are forecasting CPI at 2.9% for
2011, reaching 3.4% in 2012.
In 2011, we expect commodity prices to continue torise. Similarly, export volumes should also rise over
the next few years but at a slower pace in 2011
because of the recent floods which have hurt trade
exports in Q1 and could persist through to Q2.
Nomura Market Nomura Market
Recent
Q1 11 0.98 1.00 1.27 1.32
Q2 11 0.98 1.00 1.23 1.30
Q3 11 1.00 1.01 1.22 1.31
End 2011 1.02 0.98 1.21 1.29
0.99 1.35
FX Forecast AUD/USD
AUD/USD AUD/NZD
16 March 2011Contributing Research Analysts
Geoffrey Kendrick+ 44 20 7103 [email protected]
ennifer Hau+44 20 7102 [email protected]
Terms of Trade (page 3) bullish
bullish
Valuation & competitiveness (page 8-9) very bearish bearish
Official Capital Flows (Page 12) bullish
Fiscal Policy (Page 12) very bullish
Housing (page 13) neutral
neutral
Note: Very bullish
Bullish
Neutral
Bearish
Very bearish
Global USD Direction
Global Risk Sentiment neutral
Key factors in the AUD outlook
Country-specific factors
Rate differential (page 2) Direction: bullis h
Global factors
Resource production (page 4-6)
Private Capital Flows (Page 10-11)
Mispricing: bearish
Source: Nomura, Reuters, RBA and IMF
2011 2012 2011 2012
Nomura 3.3 3.6 3.1 3.1
Consensus 3.2 - 3.2 -
RBA 3.8 4.0 3.0 3.0IMF 3.5 3.5 3.0 3.0
Economic Forecast
GDP Inflation
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]8/6/2019 Strategic AUD Views - Mar 2011 Edited
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Nomura | Strategic Currency Views: AUD March 16, 2011
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Policy rate (bullish short term)
The RBA kept rates unchanged at 4.75% at the March meeting as widely expected. Market expectations
have declined since the severe floods in December/January. Before the floods the market had priced ina hike in August this year, but it has now pushed back expectations. Although 4.75% is a low cash rateby historical standards, the RBA estimates that wider bank margins since the onset of the crisis (andAustralia's early adoption of Basel III rules) have added a further 150bp to average flexible mortgagerates. This puts the cash rate mildly into restrictive territory.
The RBA has now hiked rates seven times in 13 months, taking the cash rate from 3.0% to 4.75%. Oureconomists believe two more hikes are likely, one in May and another in Q3 leaving rates at 5.25% by theend of 2011. This would be a positive surprise compared with market expectations. The main risk to thisview is that the Bank stays on hold longer than expected, as per market pricing.
In its February quarterly Monetary Policy Statement, the RBA forecasts for core CPI inflation remainedunchanged at 2.75% for end-2011 and 3% for end-2012. This signifies a mild tightening bias. The Bankcontinues to suggest the level of AUD is helping to restrain inflationary pressures domestically. This means
that a stronger AUD reduces the likelihood of further RBA hikes from here.
The recent flood and cyclone are expected to have an upward pressure on inflation. We estimate 0.3pp willbe added to inflation from the higher cost of goods caused by a loss in production mainly from fruit andvegetables.
AUD/USD continues to trade at elevated levels and it remains higher than rate differentials would suggest.
Source: RBA, Bloomberg, Nomura.
4.25
4.50
4.75
5.00
5.25
5.50
Mar-11 Jun-11 Sep-11 Dec-11
Rate Expectations for Australia
Market
Nomura
%
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
-3500
-2500
-1500
-500
500
1500
2500
Jul 95 Jul 98 Jul 01 Jul 04 Jul 07 Jul 10
RBA FX Intervention
RBA FX Intervention - lhs
AUD/USD - rhs
$AUD mn
RBAbuys AUD
RBAsells AUD
AUD/USD
0.5
0.6
0.7
0.8
0.9
1
1.1
0
1
2
3
4
5
6
7
8
Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11
AUD/USDRate diff
3M Bills Implied Rate differential
AUD 3M bank bill - US 3M T-Bill
AUD/USD 0.6
0.65
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
5.50
Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
Futures Implied Rate Differential(Dec 2011 Contract)
Futures di ff
AUD/USD
%AUD/USD
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Terms-of-trade (bullish) Australia's terms of trade have increased rapidly
over the past few years. Export prices (mainlycommodities) have risen sharply, while Australia'simport prices (primarily manufactured goods)remaining subdued, especially in AUD terms as thecurrency has appreciated. The terms of tradecontinue to increase.
However, China (Australias number one exportdestination) has started tightening its policy, hiking1-year deposit and lending rates by 25bp and bankreserve requirements by 100bp since the beginningof this year. As China becomes more serious abouttightening, we could see growth in China wane,which could impact demand for Australiascommodity exports
Commodity prices rose sharply in January as aresult of the recent (Dec/Jan) natural disasters.The floods in Queensland had a significant impacton coal production, with around 25% of
Queenslands coal mines ceasing operations andanother 60% operating under restrictions. Exportswere affected because of damaged rail lines. Thisled to a lack of supply, causing coking coal pricesto rise. Cyclone Yasi also impacted commodityproduction from Northern Queensland, wherebanana crops, sugar cane and beef herds wereaffected.
In 2011 we expect commodity prices to continue torise. The increased concerns about events in theMiddle East have caused oil prices to rise, and wenow forecast them to rise as much as 30% in 2011.
Similarly, export volumes should continue to riseover the next few years, but at a slower pace in2011, given the recent floods. These hit tradeexports in Q1 and the effects could persist throughto Q2. We forecast export volumes to rise from23.4% of GDP in 2010 to 24.1% in 2011 and24.9% in 2012. We expect 2011 growth to coincidewith strong growth in demand from Asia ex-Japan.Growth will be negative in Q1 because of thefloods but should pick up in Q2 and for the rest ofthe year. In 2012 production of liquid natural gas(LNG) and gold should increase.
*Nomura Forecasts
*Note: Rural: livestock, wheat, wool, rice and other foods.Base Metals: Aluminium, Copper, Lead, Zinc, Nickel.
Non-rural: Coal, Iron Ore, Gold, LNG, Oil and Alumina.
Source: Bloomberg, DataStream, Nomura.
60
65
70
75
80
85
90
95
100
105
110
50
100
150
200
250
300
Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11
Nomura ToT
AUD TWI
ToT Index AUD TWI
0
20
40
60
80
100
120
140
160
180
Q11988
Q11991
Q11994
Q11997
Q12000
Q12003
Q12006
Q12009
Q12012
Australia exports vs commodity prices
AUD Export Volume index
Commodi ty Prices
Index 2009=100
80
100
120
140
160180
200
220
Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10
Export Prices
Import Prices
Index
0
50
100
150
200
250
Jan 97 Jan 00 Jan 03 Jan 06 Jan 09
Commodity Prices by components
Rural
Non-rural
Base Metals
Index 100 = 08/09
0
20
40
60
80
100
120
140
160
180
0
5
10
15
20
25
Exports vs Commodity prices
Total Exports - lhs
RBA Commod ity Prices -rhs
AUD bn Index
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Resource production (bullish long term)Chinese steel production vs iron ore and coking
coal exports from Australia (by volume) Natural gas and steaming coal exports from Australia
Iron ore exports from Australia to China vs total
China iron ore imports
Gross State Product
[last data point is Jun 2010]
Source: Port Hedland Port Authority, Australia Bureau of Statistics, Bloomberg, Nomura
Chinese demand for steel and energy has dominated Australia's export mix for the past decade. Chinese steelproduction has multiplied more than fourfold over the past seven years, seeing Australia's exports of iron ore
more than double.
In addition, the opportunities afforded by long-term Chinese energy contracts to Australia's LNG industry have ledto an almost exponential increase in production (all for export) of LNG off Australia's north and north-west
coastlines. The days of the original north-west shelf trains 1-3 (7.5 million tonnes annual production in the 1990s)
are now long gone (see Box 1 Liquid Natural Gas: Australia's new iron ore sized export in the report The
Australian Dollar: Its not all about Chinafor more details). Similar increases in productive capacity have occurred
in thermal (steaming) coal production and exports, assisted by huge upgrades to rail and port facilities in New
South Wales and Queensland.
From a structural perspective this has started to result in a genuine two-speed Australian economy. Thecommodity states (here represented by West Australia, Queensland and the Northern Territory) have grown by anannual average 4.1% over the past five years, in stark contrast with the 2.5% average for the rest of Australia.
While the risk of "Dutch disease" has gained little credence of late, we think it is something to consider longer
term.
50
100
150
200
250
300
50
100
150
200
250
300
350
400
450
03 04 05 06 07 08 09 10 11
China Steel Production - lhs
Iron Ore - rhs
Coal - coking - rhs
Index Index
0
500
1000
1500
2000
2500
1990 1994 1998 2002 2006 2010
Natural Gas
Coal - Steaming
AUD mn
50
100
150
200
250
300
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
China Total Iron Ore Imports
PortHedland Exports to China
Index
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
90 92 94 96 98 00 02 04 06 08 10
Rest of Australia
Queens land,Western Australiaand No rthern Territories
y-o-y growth
http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=409442http://grp.uk.nomura.com/research/getpub.aspx?pid=4094428/6/2019 Strategic AUD Views - Mar 2011 Edited
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Exports distribution by country in 2000 Exports distribution by country in 2010
Export distribution by goods in 2000 Export distribution by goods in 2010
Source: Bloomberg, CEIC, Australia Bureau of Statistics, Nomura
Chinese demand for steel and energy has resulted in a fundamental shift in Australia's export basket mix as well asthe destination of its exports. The 1990s Japanese iron ore and coal annual renegotiations have been gradually
replaced by Chinese negotiations for the same commodities, and are now conducted quarterly, for the first time in
2010.
Although in the 1990s Japanese iron ore and coal demand was important in terms of Australia's overall exportbasket, other exports such as gold, base metals and tourism still had a large role to play. By 2010, however, while
tourism remained important, a strong AUD has meant it has been gradually priced out by an ever greater surge in
iron ore and coal exports.
China
Other
HongKongJapan
S.Korea
NZ
Singapore
Taiwan
UK
US
EUChina
Other
Hong Kong
Japan
S.Korea
NZ
Singapore
Taiwan
UK US
EU
Alumia
Aluminium
BarleyLivestock
Coal -coking Coal -
Steaming
CopperCopper
OreCottonIron Ore
LeadNatural Gas
Nickel Ore
Nickel
PetroleumOil
Wheat
Wool
Zinc
SteelNon-
FerrousMetalsGold
Other goods
ServicesEducation
ServicesTourism
ServicesOther
Alumia AluminiumBarley Livestock
Coal -coking
Coal -steaming
Copper
Copper Ore
Cotton
Iron Ore
LeadNatural
GasNickelOreNickel
PetroleumOilWheat
WoolZinc
SteelNon-
FerrousMetals
Gold
OtherGoods
ServicesEducation
ServicesTourism
ServicesOther
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Box 1 One natural disaster after another: floods and cyclones
At the end of 2010 eastern states of Australia were hit with heavy rainfall which subsequently led to one of the
worst Australian floods experienced in a century. Half of Queensland was left submerged, an area as large as
France and Germany combined. The flood caused mass disruptions, affecting mining, agriculture, tourism and
transport. Furthermore, as the worst of the flood began to fade Australia was hit by Cyclone Yasi.
Flood impact
Australia experienced the worst flood in a century during December/January. At the peak of the natural
disaster, more than half of Queensland was flooded. Floods primarily affected Queensland (mainly Brisbane),
and some parts of Victoria.
The flooding severely hit coal production, particularly in the Bowen-Basin in central Queensland which is
home to 34 operational coal mines and supplies over half of Australias coal exports. The floods caused
around 25% of mines throughout Queensland to cease operations in December/January, with another 60%
operating under restrictions. While production has recommenced, damage to rail lines will limit the delivery of
exports for some time potentially till the end of Q1.
The Reserve Bank of Australia has estimated that the flood has caused a loss of production in the region of
25 million tonnes (around 8% of annual coal production). Australia supplies over 60% of the world s export of
coking coal (Figure 1), and the decline in production means prices are set to rise. Coking coal prices (whichare now set on quarterly contract rates) have risen, reaching US$330/tonne for Apr-Jun contracts, up from the
agreed Q1 benchmark price of US$225/tonne. The floods mean prices are set to remain high for a prolonged
period, as coal mines are unlikely to be able to make up for lost output given that they were probably already
operating at full capacity.
The floods also hit agriculture, either delaying planting of new crops or damaging the current crop. Although
there were initial concerns over wheat production, ABARE estimates wheat production reached 26.3 million
tonnes in 2011, 20% higher than last year. Only 5% of Australias wheat production is from Queensland, and
the floods have only slightly reduced forecast production. Although forecasts for New South Wales and
Victoria have been lowered since the floods, they are still double the quantities produced in 2009-10 (Figure
2).
CyclonesAs the flood waters subsided, Queensland was hit by another natural disaster, Cyclone Yasi.
Cyclone Yasi was a category 5 cyclone, the strongest to hit North Queensland this century. It caused mass
damage and chaos. We estimate that the initial loss of GDP growth in Q1 will be around AUD2bn or about
0.6pp nationally. The cyclone affected various commodities. We estimate 85% of banana crops, 15% of the
beef herd and 50% of sugar cane were lost in the disaster.
Figure 1. World coking coal exports Figure 2. Wheat production by state
Source: ABARE, Nomura Source: ABARE, Nomura
0
50
100
150
200
250
300
2008 2009 2010 2011f
Other
Russia
USA
Canada
Australia
million tonnes
0
2 000
4 000
6 000
8 000
10 000
12 000
NSW Vic Qld WA SA
200809
200910
201011 f
1000 tonn es
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The cost
The Federal government has estimated the direct cost of the floods to be AUD5.6billion. It has since
introduced a one-off flood levy on income tax. The tax, which will apply for the 2011/12 tax year (July-June in
Australia), is set at 0.5% of income above AUD50,000 and 1.0% on income above AUD100,000. The
government expects this to raise AUD1.8bn. In addition to this AUD1.8bn, the Federal government is to spend
another AUD3.8bn, which will be fully funded by cuts elsewhere. There should be no net expansion on
government spending as a result of the floods, as the government aims to return the fiscal balance to surplusby 2012-13.
The RBA has forecast the flood impact to lower GDP for Q4 2010 and Q1 2011 by 0.25% q-o-q, largely
because of the loss in exports from coal production as well as other output. However, assuming there are no
further setbacks, coal production is expected to resume to full capacity by the second half of the year. With
reconstruction and repair to take place after the disaster, the RBA is estimating the cost of rebuilding public
infrastructure and dwellings to be around AUD8billion spread over two years (from mid-2011). This is
expected to boost GDP by 0.25% during the quarters when the rebuilding takes place. The RBA has therefore
revised up its forecast for 2011 GDP to 4.25% y-o-y (up from the November forecast of 3.75%) and 2012 to
4%. However, our economists are forecasting more modest growth during 2011 of 3.3% y-o-y and 3.8% in
2012.
It is assumed that a natural disaster will cause negative growth due to loss of production and output, but thatthe following quarters should experience a pick-up in activity as clean-up and rebuilding commences. Our
economists forecast the damage from the December/January flood and from Cyclone Yasi will take 1.1% off
Q1 GDP, forecasting -0.3% q-o-q for Q1 GDP, and then a pick-up in growth in Q2 to 1.9% q-o-q, and in Q3 to
1.6% q-o-q. However it is important to note that as the new flood levy comes into force in July this year,
potential spending will be reduced.
Figure 3. GDP Forecast
Source: Nomura Global Economics
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Mar 10 Sep 10 Mar 11 Sep 11 Mar 12
GDP Forecast pre-floods
GDP forecas t post-floods
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Valuation (very bearish long term)
From a longer-term valuation perspective AUD continues to look stretched to the topside: Australia'sterms of trade and commodity price basket have now surpassed the peaks reached in 2008. AUD has also
printed fresh all-time highs against USD and on a TWI basis at the start of this year.
The big positive driver for AUD has been China, its impact on commodity prices, and also the demand forAustralian exports (volumes). We think commodity prices could clearly push higher, but the inflationary
consequences of higher commodity prices for China could increase the likelihood of Chinese tightening
measures. This would reduce an otherwise positive AUD stimulus, so risks are becoming skewed to the
downside (for more details seeAUD: Getting bearish, 1 February 2011).
Source: Bloomberg, OECD, Nomura.
USD GBP EUR JPY AUD NZD CAD CHF NOK SEK
REER (10y) -10.96 -13.39 3.43 12.68 22.33 -1.49 17.97 14.97 3.62 0.02
REER (20y) -9.93 -12.04 -3.31 13.71 30.37 2.35 22.13 14.46 6.82 -7.30
REER (30y) -12.90 -12.37 -6.54 23.82 25.33 3.18 17.64 16.89 5.41 -11.72
PPP (OECD) -25.09 6.79 8.80 26.49 50.97 11.64 19.01 38.80 38.24 28.22
PPP (Adjusted) -12.49 0.42 0.92 1.27 50.78 19.98 23.71 -0.82 3.68 4.91
G10 Valuation (%)
51.0
-40
-30
-20
-10
0
10
20
30
40
50
60
1971 1979 1987 1995 2003
AUD/USD deviation from PPP%
AUD Overvaluation
25.3
-30
-20
-10
0
10
20
30
40
50
60
1964 1970 1976 1982 1988 1994 2000 2006
REER deviation from 30-year average
AUD Overvaluation
%
60
65
70
75
80
8590
95
100
105
110
50
100
150
200
250
300
Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11
Nomura ToT
AUD TWI
ToT Index AUD TWI
0.40
0.50
0.60
0.70
0.80
0.90
1.00
1.10
0
20
40
60
80
100
120
140
160
Jan -97 Jan -00 Jan-03 Jan -06 Jan -09
RBA Commodity Prices
AUD/USD
Index AUD/USD
http://www.nomura.com/research/getpub.aspx?pid=416366http://www.nomura.com/research/getpub.aspx?pid=416366http://www.nomura.com/research/getpub.aspx?pid=416366http://www.nomura.com/research/getpub.aspx?pid=4163668/6/2019 Strategic AUD Views - Mar 2011 Edited
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Australia total exports vs total imports of maintrading partners
Manufacturing exports picked up at the end of 2010. Butthis sector only counts as a small portion of Australias
total export income.
In terms of total exports, Australias market share hasincreased significantly over the past few years, with
continued growth in exports (due to increase productive
capacity) despite a drop in export market potential during
the crisis.
Australias unit labour costs have increased graduallyover time. We find that AUD vs USD and NZD is currently
at relatively fair values compared with the REERs
adjusted for bilateral CPIs and ULCs. However, with
AUD/JPY we find that AUD is relatively undervalued
looking at bilateral ULCs. *Export market share based on the top trade weighted tradingpartners to Australia ex China.
Source: Bloomberg, DataStream, OECD, RBA, Nomura.
-60%
-40%
-20%
0%
20%
40%
60%
80%
Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11
Manufacturing Exports
AustraliaNew ZealandUKNorway
y-o-y
80
100
120
140
160
180
200
220
Q11995
Q11997
Q11999
Q12001
Q12003
Q12005
Q12007
Q12009
Total imports of maintrading partners
Australia exports
Index 100=1995
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
1.1
1.15
1.2
Q11995
Q11997
Q11999
Q12001
Q12003
Q12005
Q12007
Q12009
Australia export market share
Australia exports/ Totalimpo rts of main tradingpartners
ratio
60
80
100
120
140
160
180
200
Q11990
Q11993
Q11996
Q11999
Q12002
Q12005
Q12008
Unit Labour Cost
UKGermanyNorwayNew ZealandJapanUSAustralia
Ind ex 100 = 1990
50
70
90
110
130
150
170
190
Jun 96 Jun 98 Jun 00 Jun 02 Jun 04 Jun 06 Jun 08 Jun 10
AUDJPY bilateral real exchange rates
AUDJPY adjusted by CPI
AUDJPY adjusted by ULC
AUDJPY Spot
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
Jun 96 Jun 98 Jun 00 Jun 02 Jun 04 Jun 06 Jun 08 Jun 10
AUDUSD bilateral real exchange rates
AUDUSD adjusted by CPI
AUDUSD adjusted by ULC
AUDUSD Spot
1
1.1
1.2
1.3
1.4
1.5
Jun 96 Jun 98 Jun 00 Jun 02 Jun 04 Jun 06 Jun 08 Jun 10
AUDNZD bilateral real exchange rates
AUDNZD adjusted by CPI
AUDNZD adjusted by ULC
AUDNZD Spo t
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Private capital flows ( neutral)
The Australian current account has persistently been in deficit owing to continued net outflows from its
income balance. However, it has been narrowing since early 2010.
In recent quarters there has been an improvement in the goods and services trade balance mainly owing torising commodity prices. This has subsequently reduced the current account deficit.
Australia is considered an attractive investment destination with consistent portfolio inflows, a majority beingpurchases of bonds. Foreign investors have shied away from Australian stocks since Q3 2009. Domesticinvestors have reduced their investments abroad over the past two quarters with a notable reduction ininvestments in both foreign stocks and bonds.
Direct investments in Australia have been volatile for years. The recent decline in foreign investments could beattributed to the increase in value of the Australian dollar, which is considered to be 40% overvalued on a PPPbasis.
Source: Australia Bureau of Statistics, Bloomberg, Nomura.
-100
-80
-60
-40
-20
0
20
40
Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010
Current Account Balance
Inco me BalanceGoods and services balanceCurrent TransfersCurrent Account
AUD bn,annulaised
-150
-100
-50
0
50
100
150
200
Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010
Financial Account Flows
Net Portofl io InvestmentOther InvestmentNet Direct InvestmentFinancial Account
AUD bn,annulaised
-200
-150
-100
-50
0
50
100
150
200
250
Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010
Portfolio Inflows
Bonds
Equity
total inflow
AUD bn,annualised
-200
-150
-100
-50
0
50
100
Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010
Portfolio Outflows
Bonds
Equity
total outflow
AUDbn,annualised
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Private capital flows: M&A ( neutral)
6M Aggregate Pending Flows Adjusted net pending flows with probabilityadjustment vs 6M net pending flows
The Australian M&A picture has weakened. Australias six-month aggregate pending flows are reporting anexpected inflow of $11bn in February. When looking at the actual likely FX impact, the adjusted netpending flow
1indicates a small inflow of only $1.4bn.
There continues to be some sizable announced deals coming into Australia, but it is important to note that notall the flow listed below will provide a cross-border inflow. Taking into account just cross-border cash flow andthe likelihood of the deals completing (based on the current trading stock price to the offer price), we find theadjusted net pending inflow to be just $2bn.
There has also been an increase in outflows from announced deals from Australia with outflows totalling$10.3bn in February.
Australia is currently ranked fifth in the G20 in terms of adjusted net pending inflow.
*Note: Estimate for Q1 2011
Source: Thomson Reuters, Nomura.
1) Adjusted net pending flows are estimated by taking major deals and adjusting cross-border cash flows according to additional information we know about the dealthis can include financing details, a differing currency for the working capital. This is then adjustment to incorporate the likelihood of a deal being completed. For moredetails seeM&A activity slows in January, 1 February 2011.
-40
-30
-20
-10
0
10
20
30
99 00 01 02 03 04 05 06 07 08 09 10 11
Pending flows - total
Pending flows - cash
$ bn
-20
-15
-10
-5
0
5
10
15
20
CNY JPY BRL MXN EUR AUD CAD KRW GBP USD
6M Adjusted net pending flow - withprobability adjustment - cash
6M Net Pending Flow - cash
US$bn
-35
-30
-25
-20
-15
-10
-5
0
5
10
15
20
Mar-05 Sep-06 Mar-08 Sep-09 Mar-11
Net cash Announced
$US bn$US bn
-20
-15
-10
-5
0
5
10
15
20
25
Mar-05 Sep-06 Mar-08 Sep-09 Mar-11
Net Total Completed$US bn
Acquirer Target Total Value
($m)
Cash
($m)
Equity
($m)
Outflows BHP Billiton Ltd Australia Chesapeake Energy Corp US 4,750 4,750
Equinox Minerals Limited Australia Lundin Mining Corporation Canada 4,700 2,400 2,300
Inflows Singapore Exchange Ltd Singapore ASX Ltd Australia 8,235 3,817 4,507
Rio Tinto PLC United Kingdom Riversdale Mining Ltd Australia 3,781 3,781
AXA SA France AMP Ltd Australia 2,631 2,631
http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=4163558/6/2019 Strategic AUD Views - Mar 2011 Edited
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12
Official capital flows (bullish)
% of allocated reserves
Change in holdings (per quarter) * Other currencies include AUD,NZD, CAD, SEK and NOK.
In Q3 2010 there was strong demand for other currencies from the SNB. However, the COFER datashowed that official demand was moderate during that period. The latest SNB FX intervention datashowed there were no additional purchases of other currencies in Q4. We believe official flows will
remain supportive for AUD but are unlikely to drive AUD/USD any higher from current levels. During H1 2010 we saw strong inflows into other currencies suggesting central banks started to diversify
their foreign exchange reserves away from USD and EUR (because of continued debt issues in peripheralEurope and growth and QE uncertainties in the US). However, recent data suggest central banks aresticking to USD and EUR, rather than pursuing aggressive diversification strategies.
The most recent IMFs COFER data showed moderate demand for other currencies in Q3. Much of thisdemand was driven by the SNB FX intervention the Bank bought CHF5.9bn of other currencies (defined asAUD, SEK, DKK and SGD, although we suspect the bulk was in AUD) in Q3 2010. However, recent SNB FXintervention data showed no additional purchases during Q4.
Source: IMF, Nomura.
Fiscal policy (very bullish)
Source: IMF, Nomura.
Australia has one of the strongest fiscal positions in the G10. In the current environment, where investorsare concerned about sovereign risk, this is bullish AUD.
Australia has one of the strongest fiscal positions and has the lowest gross debt within the G10. The currentfiscal deficit of 4.1% of GDP in 2010 is widely expected to shrink gradually over the next few years, with therecent government budget for 2010-11 projecting a fiscal surplus by 2013.
The government estimates the direct cost of rebuilding after the severe floods experienced inDecember/January at AUD5.6bn. The government has proposed a flood levy on taxable incomes to fund therepairs. This is set to raise AUD1.8bn. The rest of the rebuilding cost will be funded by AUD3.8bn of netbudget cuts. This shows the governments strong commitment to return its budget to a surplus by 2012-13.
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09
OTHER World
OTHER World
-10
-5
0
5
10
15
20
25
30
35
Jun-99 Jun -01 Jun-03 Jun-05 Jun-07 Jun-09
$bnOTHER
-15
-10
-5
0
5
10
15
Irelan
d
UnitedState
s
Japa
n
UnitedKingdo
m
Greec
e
Spa
in
France
Portug
al
Netherlands
Belgiu
m
Ita
ly
Austr
ia
German
y
NewZealan
d
Luxembou
rg
Canad
a
Australia
Finland
Swede
n
Switzerlan
d
Norwa
y
2011 Fiscal Deficit%GDP
0
50
100
150
200
250
J
apan
Greece
Italy
Belgium
Ireland
UnitedS
tates
Fr
ance
Por
tugal
UnitedKingdom
Ca
nada
Germany
Au
stria
S
pain
Netherlands
No
rway
Finland
Sw
eden
Switze
rland
NewZealand
Aus
tralia
Luxemb
ourg
2011 Gross Debt%GDP
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Housing ( neutral)
House price growth
Source: Reserve bank of Australia, Bloomberg, Australia Bureau of Statistics, Nomura
House prices could be topping out. They have declined year-on-year since early 2010. This could be due tothe mildly restrictive mortgage rates that households face; banks have added a further 150bp to averageflexible mortgage rates since the onset of the crisis.
Source: Bloomberg, Australia Bureau of Statistics, Nomura
0.5%
1.0%
1.5%
2.0%
2.5%
100,000
120,000
140,000
160,000
180,000
200,000
220,000
240,000
1980 1985 1990 1995 2000 2005 2010
Building Approvals vsPopulation Growth
Build ing Approvals -lhsPopulation Growth - rhs
annualised y-o-y
-20%
-10%
0%
10%
20%
30%
40%
50%
60% Sydney
Melbourne
Brisbane
Adelaide
Perth
%y-o-ygrowth
0
2
4
6
8
10
12
14
16
18
1980 1984 1988 1992 1996 2000 2004 2008
Real Household disposable income
Real Household consumption
% y-o-y
-6%
-4%
-2%
0%
2%
4%
6%4
5
6
7
8
9
10
11
12
1980 1984 1988 1992 1996 2000 2004 2008
Unemployment rate - lhs
Employed - rhs
% % y-o-y, inverted
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Uridashi/toshin flows (bearish potential)Outstanding Toshins by currency
Lower yields since 2008 have reduced the attractiveness of uridashi investments to Japanese retail investors.
However, with rates in Australia sustainably higher than in New Zealand for the first time under the currentcentral bank regimes (the RBNZ introduced its OCR framework in 1999), all of the Australasian uridashi flowshave been going to Australia (in the most recent three-month period 76% of these combined flows found theirway to Australia compared with an average of 67% in pre-crisis 2007).
The recent floods could cause concern for Japanese investors and therefore impact flows into Australia. Thissuggests a further sharp increase in toshin flows to Australia is now less likely.
Source: Bloomberg, Nomura.
Risk environment ( neutral)
*A proxy for Global liquidity is calculated by looking at globalcentral bank reserves vs money in circulation in US and Japan
Historically, AUD/USD trades closely with the global risk environment. However, recently there has been adivergence between long-run GRAM+ and AUD/USD.
We find AUD also trades with global liquidity. AUD gained vs GBP, EUR, CHF and USD since early 2009, asglobal liquidity has started to grow strongly again, following the dip in 2008.
Source: CEIC, Bloomberg, Nomura.
3
4
5
6
7
8
9
0
1
2
3
4
5
6
Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11
AUD issuance
AUD 3Y Swap
%Uridashi Issuance AUD bn
0
5
10
15
20
25
30
35
40
99 00 01 02 03 04 05 06 07 08 09 10 11
Others
Latin America
XJ-Asia
Other Europe
Euroland
Canada
New Zealand
Australia
UK
US
(\tn)
(CY)
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
Apr 92 Apr 96 Apr 00 Apr 04 Apr 08
Long-Run Gram+
AUDUSD
AUDUSDLR GRAM+ Long Run GRAM+ vs AUDUSD
-30%
-20%
-10%
0%
10%
20%
30%
40%
-10%
-5%
0%
5%
10%
15%
20%
25%
Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10
Global Liquidity vs AUD returns
Global l iquidity proxy
AUD vs GBP, EUR, CHF andUSD
% y-o-y proxy % AUD returns
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15
Positioning (bearish)
AUD IMM positioning is currently at extended levels of US$7.44bn. It is just below the all-time high seen inApril 2010.
AUD TFX positioning is also at extended levels reaching an all time high of JPY210bn.
Source: Bloomberg, CME, TFX, Nomura
Implied volatility
The volatility curve is a slightly higher than one-month ago suggesting a decline in market risk sentiment.
Implied volatility in AUD/USD options is now at its long-term average and is relatively similar to the historicalvolatility.
Source: Bloomberg, Nomura.
0.55
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00
1.05
-4
-2
0
2
4
6
8
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
IMM Positioning
AUD IMM positioning - lhs
AUDUSD - rhs
$US bn AUD/USD
50
60
70
80
90
100
110
120
0
50
100
150
200
250
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
TFX Positioning
AUD TFX positioning - lhs
AUD/JPY - rhs
JPY bn AUD/JPY
9
10
11
12
13
14
15
16
1w 2w 3w 1m 2m 3m 4m 5m 6m 1y 18m 2y
Volatility Curve
Now
1-mth ago
3-mth ago
vo l
5
10
15
20
25
30
35
40
45
50 VolatilityHistorical
Implied
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Data surprise index (bearish)Our growth surprise index has been on a decliningtrend since 2010. At the end of last year we sawlower than expected Q4 CPI, Q3 GDP and tradedata. But recent employment data came in betterthan expected, causing the index to move higher.
There has been a large divergence between theindex and AUD/USD since the middle of last year.AUD/USD has got progressively higher while theglobal surprise index has declined. This suggeststhat AUD/USD should trade lower as AUD/USDconverges towards the index.
Source: Bloomberg, Nomura.
0.6
0.65
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
1.1
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5Data Surprise
AUD GSI
AUDUSD
AUD/USDGSI
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17
APPENDIX A1
ANALYST CERTIFICATIONS
We, Geoffrey Kendrick and Jennifer Hau, hereby certify (1) that the views expressed in this report accurately reflect my personal views aboutany or all of the subject securities or issuers referred to in this report, (2) no part of my compensation was, is or will be directly or indirectlyrelated to the specific recommendations or views expressed in this report and (3) no part of my compensation is tied to any specific investmentbanking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
Issuer Specific Regulatory Disclosures
Mentioned companies
Issuer name Ticker Price Price date Stock rating Sector rating Disclosures
Rio Tinto RIO LN 3964p 11-Mar-2011 Buy Bullish 49,141
Rio Tinto Ltd RIO AU 79.15 AUD 14-Mar-2011 Not Rated
Disclosures required in the U.S.
49 Possible IB related compensation in the next 3 monthsNomura Securities International, Inc. and/or its affiliates expects to receive or intends to seek compensation for investment bankingservices from the company in the next three months.
Disclosures required in the European Union
141 Analyst shareholding in covered companyAn analyst who was involved in preparing the research recommendation in respect of Rio Tinto plc referenced in this report, or a memberof the analysts household, holds securities of the subject company
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