For two weeks in a row now the Australian Dollar (AUD) has failed to break through its resistance level of $1.08 with the USD.

There are numerous reasons for this including a recent bout of political instability between the incumbent Prime Minister and a challenger. Another, is a broadly held market view that even though the Reserve Bank surprised market observers by failing to lower interest rates in February, it is not the end of the current cycle of interest rate cuts.

However the bigger picture with the AUD is China and Resources. At FX Strategy we view the AUD as a proxy for Chinese growth and also as a bet on commodity prices. And this is where our negative view on the AUD heading much higher is founded – commodity prices. There is an increasing body of evidence that commodity prices have peaked and the recently released half yearly results my Aussie mining companies including BHP and RIO potentially confirm this scenario.

Adding further weight to our view here at FX Strategy that the AUD may be reaching its peak is recently released data from the OECD regarding Purchasing Price Parity (PPP). The OECD’s study found that Australia is the 3rd most expensive country in the world in which to buy a common basket of goods – beaten only by Norway and Switzerland. The USA was 38% cheaper! Meanwhile, data from the Economist Intelligence Unit adds impetus to this view - placing Sydney and Melbourne as the 7th and 8th most expensive cities in the world.

On the other side of the ledger is the counter argument that the Australian mining boom has made Australians very rich and even more so when you add in the effects of the strong AUD on the lower cost of imported goods. This has resulted in incomes rising faster than the cost of living. With this in mind UBS produced recent data that suggests Australia is the second cheapest (behind Zurich) developed country in which to live based on the number of hours needed to work to pay for the basket of goods.

Often in the macro and indeed in the micro world of economics, given enough time things revert to the mean and back to long run averages. We find it very hard to look at the AUD and believe it is reasonably prices on a long term outlook. As such, finding ways to identify what might cause the AUD:USD to decline could turn out to be a profitable trade in the long run.

By Friday Fundamentalist, Published on 26th of February 2012
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