Investing

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.

• South Africa
• Malaysia
• Hong Kong
• Phillippines
• Thailand
• Iindonesia
• China

The following countires fell off the list, even though they are still undervalued, just the AUD fell further

• Taiwan
• Russia
• Japan
• Singapore
• South Korea
• Chile
• Mexico

Of the major currencies that I might invest in

• Canada could see a 33% depreciation against the AUD,
• USD 40% depreciation against the AUD,
• Euro 50%depreciation against the AUD,
• Japan 28% depreciation against the AUD,
• New Zeland 21% depreciation against the AUD,
• Singapore 18% depreciation against the AUD.
  
  On the upside
• China has about 17% upside but is pegged,
• Indonesia and Thailand have 20% upside,
• Hong Kong has 25% upside but is pegged,
• Malaysia has 40% upside and
• South Africa 42% upside.

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.