Summary

• Commodities may be ending their cyclical bear market, so now may be a good time to look at the Australian Dollar.
• However, given the continued strength of the U.S. Dollar, selling U.S. Dollars for Australian Dollars is not the right choice.
• Investors should consider selling their Japanese Yen for Australian Dollars.

While some people like to operate in the limelight, others prefer to work behind the scenes. These are the introverts and the extroverts — both can get the work done, but in their own form and fashion. The bear market in commodities brought some opportunities for investors, one being the Australian Dollar or Aussie. As iron ore prices declined, so did the Australian Dollar as Australia is a major exporter of the product. But the extroverted AUD/USD (Australian Dollar versus U.S. Dollar) may not be the best option given the volatility. Taking a position in the AUD/USD while the currency pair is in a current downtrend may prove deleterious. Therefore, it would not be wise to sell your U.S. Dollars for the Aussie. Investors would need to go behind the scenes and look for relatively introverted strategies. One such strategy is to buy the Australian Dollar and sell the Japanese Yen by going long AUD/JPY. To replicate the long AUD/JPY, an appropriate alternative for investors without Forex accounts would be to consider the ETFs the CurrencyShares Australian Dollar Trust ETF (NYSEARCA:FXA ) and the CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY ) by going long FXA and going short FXY.

Economic Activity

The Australian economy has been relatively solid, given the decline in commodity prices in the last 8 months. Latest figures show that the Australian economy grew 2.7% year over year in September 2014, in line with the 4-quarter moving average. Resource exports and dwelling investment contributed to the growth, however, the rate of consumption grew at a below-trend pace despite being supported by the low interest rate environment. Growth of private non-mining business investment and public demand remained subdued while mining investment fell further. Export volumes continued to grow strongly over the 2nd half of 2014, driven by resource exports. Australian production of coal and iron ore is expected to remain at high levels despite the large fall in prices over the past months. The Reserve Bank of Australia (RBA) expects the production capacity for LNG to rise over 2015. Service exports, including education and tourism, have risen a little over the past 2 years, and the RBA thinks that it will rise further as a result of the decline in the Australian Dollar. Australia’s housing market continues to benefit from the low interest rate environment and strong population growth. Dwelling investment has grown strongly since mid-2013, and a range of indicators point to further growth in the near term.

Chart 1 — Australia GDP Y-o-Y (%) as at September 2014

Source: Bloomberg

The RBA expects Australian GDP to grow at a below-trend pace during the first half of 2015 before building momentum as consumption growth improves, non-mining business investment lifts, and LNG exports increase.

Chart 2 — Australia GDP Growth Forecast

Australian CPI fell to 1.7% year over year, primarily as a result of the decline in the oil market and the repeal of the carbon price. Australia’s inflation rate is currently trading below its 4-quarter moving average of 2.5%.

Chart 3 — Australian CPI Y-o-Y (%) as at December 2014

Source: Bloomberg

The RBA expects inflation to remain below the 2%-3% target in year-ended terms over most of 2015, before picking up a bit to be consistent with the inflation target.

Chart 4 — Australian Trimmed Mean Inflation Forecast*

The RBA dropped its benchmark cash rate to the historical low of 2.25% to support the economy. These accommodative measures should bode well over the next couple of quarters, making a position in Australia attractive relative to other assets of similar credit quality.

Chart 5 — RBA Cash Rate as at January 2015 (%)

Looking at Japan, the country entered into a recession despite the Quantitative Easing program currently being implemented. Latest figures show that Japanese GDP fell 1.3% in the 3rd quarter of 2014.

Chart 6 — Japan GDP Growth Y-o-Y (%) as at September 2014

Source: Bloomberg

The reason is as a result of the consumption tax hike in the middle of 2014. The recession will be compounded with disinflationary pressures as a result of declining energy prices. Japan’s core CPI fell to 2.5% year over year in December 2014, down from 2.7% in November. Subtracting the impact from April’s sales tax increase, the CPI would have been 0.5%. This is a far cry from the Bank of Japan’s 2% inflation target. These disinflationary pressures would cause Yen strengthening.

Chart 7 — Japan Inflation Y-o-Y (%) as at December 2014

Source: Bloomberg

A focus is also required on the extroverted U.S. In its latest FOMC statement, the Fed thinks that the U.S. economy is growing at a solid pace. Labor market indicators have improved further as job gains grew and the unemployment rate fell. Household spending is also showing signs of improvement as a result of the decline in energy prices. Businesses have also been investing while core inflation remains low but stable. The Fed thinks that the U.S. economy will continue to expand moderately with improvements in labor market conditions. The tables and charts below show the Fed projections as at December 2014.

Table 1 — Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, December 2014

Source: Federal Reserve

Chart 8 — 10 — Central Tendencies Of Economic Projections, 2014-2017 And Over The Longer Run

Source: Federal Reserve

Initial estimates show that the U.S. GDP grew 2.5% year over year in the 4th quarter of 2014. This rate is above the 4-quarter moving average of 2.4%, so the U.S. is still growing at an above-trend pace. Consumer spending was strong as real PCE rose 4.3% versus 3.2% in the previous quarter. This was the strongest quarterly increase in the post-financial-crisis era. Residential investment improved given the loosening of mortgage credit, and this trend is likely to continue.

Chart 11 — U.S. GDP Growth Year-Over-Year (%) as at December 2014

Source: Bloomberg

Trade Idea

Behind the scenes, the commodity market has been in a bear market over the past 9 months. The recent 20% move in the oil market is sending a signal that another cyclical bull market in commodities is approaching. Also, with the Japanese Yen at a more accommodative position than both the Australian Dollar and the U.S. Dollar, AUD/JPY is considered an optimal position to take advantage of improvements in the Australian economy.

Observing the price data on AUD/JPY, the RSI emerged out of oversold territory while the MACD made a positive crossover, signaling an upward move in the FX pair. AUD/JPY is currently testing the 93 price level, and if it breaks through, the next level to watch is near the 50-day moving average of 95.804. Despite the positive moves in AUD/JPY over the last couple of weeks, bearish signals have also been observed, so investors should be cautious unwinding the AUD/JPY position if its price falls below 89.39.

Overall, the conditions are ripe for a position in AUD/JPY, as investors can take advantage of the situation through long FXA and short FXY.

Chart 12 — AUD/JPY Daily Candlestick Chart as at 10 th February, 2015

Source: Bloomberg

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.