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    Saturday, October 25, 2008


    Purchasing Power Parity Valuation for the Australian Dollar

    With the recent, incredible, drop in the Australian dollar foreign stocks look a lot more expensive based on purchases with AUD. It's very likely that the AUD will eventually appreciate against the USD and lots of other currencies but any investment in those other currencies has an automatic headwind once that happens.

    I used the Economist Big Mac Index as published in July 2008 and updated it with the most recent exchange rates. The economist calculated that the AUD was 6% undervalued in July 2008 (at 0.97), that has now moved to 40% undervalued (at 0.62). In July there were 14 major currencies that were cheaper than the AUD, now there are only 7.The following countires fell off the list, even though they are still undervalued, just the AUD fell further

    Of the major currencies that I might invest in Those countires with even weaker, unpegged, currencies than the AUD are not exactly the most desireable investment locations!

    For example imaging buying a canadian company for $2 CAD with $2.51 AUD at today's exchange rates. If that company rises to $20 CAD but exchange rates move to purchasing power parity then that $20 CAD becomes $16.8 AUD. That is a 6.7 times return instead of the 10 times return in Canadian dollars.

    Conversely buying a Hong Kong company at $2 HKD for 41c AUD today would be $5.18 AUD if the company rose to $20 HKD and the currencies moved to PPP. A 13 times return in AUD for only a 10 times return in HKD. Unfortunately the HKD (and largely the Chinese RMB) is still pegged to the USD so it's likely to be weak in the medium term until the pegged is eventually dropped.

    The bottom line is that Australian companies with expenses in AUD have a 20%-40% appreciation advantage over other major exchanges right now. This point is unlikely to be lost on international investors for long and makes a strong case for AUD denominated accounts to remain local.
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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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