If there’s one thing I’ve learned through the years it's that when fear is prevalent, financial instruments don’t always trade off of their fundamentals. In this recent global bear market, for example, some of the currencies with the worst fundamentals were actually the ones that flourished: the U.S. dollar and the yen.
However, as the worst of the recession recedes behind us, an investor has to go back to the fundamentals, and the currency that has the beat-looking fundamental situation is the Aussie dollar.
The reasons for this are simple. For starters, the Aussie dollar has one of the highest interest rates of any currency of the industrialized nations. Their interest rate currently stands at 3 percent while many countries are near zero percent on their rates.
This is important because money seeks yield.
Think of it in local terms. If your bank offered a savings account that earned 1 percent a year, and another bank across town offered the same account for 3 percent a year, you'd likely put your money in the latter where it would earn three times the interest as at the former bank.
It’s no different for currencies. When markets begin to normalize, money goes back into the yield-seeking mode. This is beginning even now as the Aussie dollar has been the biggest percentage gainer of the last month and calendar year.
The next reason why the Aussie dollar has the superior fundamentals is because year-over-year inflation as noted by the CPI numbers shows the Australians have the highest inflation rate (3.7 percent) of any major industrialized nation. Inflation is looked at as a good thing when it comes to currency investing.
If you come from the stock markets, inflation is largely a bad thing. The opposite is true in currencies. That's because the No. 1 way that a central bank is going to tame inflation is by hiking interest rates. As rates head higher due to rising inflation, money floods into that currency because investors know that there is a likelihood that rates will continue to go higher and remain high for quite some time.
The final reason why I say that the Aussie dollar has the best fundamentals is because Australia is the only industrialized nation that has a positive annualized GDP growth right now. While it is miniscule (0.3 percent), every other major nation still has negative GDP growth. Money likes growth and Australia is still showing signs that its economy is growing.
So, when you combine all of these factors — high interest rates, high inflation, and GDP growth — you come up with a combination that no other major industrialized nation can boast.
That's why investors need to highly consider the Aussie dollar in their currency investments. It should perform much better throughout the rest of 2009 than most other currencies.
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