Australian Dollar/New Zealand Dollar Spread
As most people would expect, the Australian dollar and the New Zealand dollar are highly correlated. This makes sense because they are trading partners with a very close geographical proximity. New Zealand exports a ton of stuff to Australia, so the Kiwi economy usually mimics the Aussie economy.
The two currencies have basically moved in lock-step with each other for the last three decades (the Australian dollar became a free-floating currency in 1983 and the New Zealand dollar became a free-floating currency two years later in 1985). Although the Kiwi generally rides on the coattails of the Aussie dollar, interest rate differentials can sometimes allow the Kiwi to outperform.
The Commodity Connection
The Australian dollar and the New Zealand dollar are often referred to as ‘commodity dollars’ since they have a strong link to commodities. In particular, the Australian dollar has close ties with the gold market since Australia is the world’s third-largest gold producer.
When you look at the last couple of decades of commodity prices as represented by the Goldman Sachs Commodity Index, you can see that the overall price trends are the same and the major turning points are often synched up together. If one can identify where commodities are going, the Aussie dollar can be traded as a proxy.
Down Under, Way Down Under
Both as a ratio and a spread, the difference between the Australian dollar and the New Zealand dollar has reached an extreme low. On April 3rd the Aussie dollar had a minuscule premium of roughly one-third of a cent over the Kiwi dollar. The difference between the two currencies was nearly 1:1 in ratio terms.
This is the closest in price that these two currencies have been in at least a decade and a half. It’s not very common. The Aussie usually has a premium of a dime or more over the Kiwi. Most likely, the multi-year bear market in commodities is a main driver in the Aussie/Kiwi spread collapse.
Current Market Situation
We’re at an interesting juncture here. First of all, the Australian dollar/New Zealand dollar spread it at an extreme low. History indicates that this won’t last, so spread traders should have been watching closely for a reversal signal.
That reversal may have happened this week. The September Australian dollar/New Zealand dollar spread made a two-day close above the declining 50-day Moving Average for the first time since the first week of November. Traders now have a green light to start getting long.
Secondly, the commodities bear market into the Q1 lows is the longest commodities bear market in the last 115 years and the size of the decline is the fifth or fourth-largest in history, depending on which commodity index you’re looking at. Now that the rubber band has been stretched this far for this long, the odds are that commodities are overdue for a sizable reversal and a new bull market. So goes commodities, so goes the Aussie dollar and so goes the Australian dollar/New Zealand dollar spread.
In mid-April the Goldman Sachs Commodity Index closed above the declining 100-day Moving Average for the first time since early July and surpassed the Q1 high. Today the DJ-UBS Commodity Index closed above the declining 100-day Moving Average for the first time since June. Another 2% higher and this index will surpass its Q1 high as well. This very well could be the start of a new bull market in commodities. If so, the probabilities are extremely favorable that the Aussie will make a spectacular recovery. So should the Aussie/Kiwi spread.
Finally, the US dollar index posted a multi-year high last month. It was on a Friday the Thirteen, no less! The ten-month run that got it there increased the value of the greenback by 27%. This is the second-largest and second-longest run in over three decades of price history. The US dollar index often has a negative correlation with commodities, so the soaring greenback and simultaneous plunge in commodities is not a surprise to anyone.
With this week’s upside breakout in the Aussie/Kiwi spread and the bullish trend change in the commodity indices, it is certainly fitting that the US dollar index triggered a bearish trend change this week as well. On the daily timeframe, the greenback made a two-day close below the rising 50-day Moving Average for the first time since early July. The long-term timeframe caught up with the reversal signal today when the buck cracked the March low. Over the last ten months, the dollar has only broken a prior month’s low on one occasion and it was a mere one-tick infraction. Today’s price break altered this price structure and confirms the bearish trend change from the daily timeframe.
There’s a saying that things happen in three’s. This week’s simultaneous trend changes in the Australian dollar/New Zealand dollar spread, the commodity indices, and the US dollar index certainly counts for that. The problem is that it happened with such gusto that a counter-trend move could happen before we go into the weekend and the new month. But one man’s misfortune can be another man’s fortune. So instead of buying the breakout right here, our opinion is that a trader may want to initially look for some sort of pullback to establish a long position.
Now that it has been broken, the 50-day Moving Average (currently around 2.62 cents) becomes new technical support for the September Australian dollar/New Zealand dollar spread. Coincidentally, a Fibonacci .382 retracement of the recent rally from the contract low is at 2.64 cents. Therefore, buying a pullback into this confluence of technical support might be a good way to get the ball rolling.
For tracking purposes, the blog will make a hypothetical trade by buying one 100,000 (AD) September Australian dollar contract and simultaneously selling one 100,000 (NZD) September New Zealand dollar contract at a spread of 2.60 cents (premium Aussie). Initially, the spread will be liquidated on a two-consecutive day close below 0.60 cents (premium Aussie).