This from The Sovereign Society:

Over the next six to eight months, our core trading strategy is based on three key ideas:

1. Global demand will continue to deteriorate
2. China will surprise on the downside
3. Commodities prices will sink back to their 2001 levels

Based on these three views, my trading partner Jack Crooks and I are bearish on currencies that depend on commodities to support their growth. And within the pack of commodity players we are most bearish on the Australian dollar.

Right now, Australia is effectively a satellite country of China. In my opinion, the market is not even close to pricing in the plunging growth in either country just yet. But when the market does, I believe the Australian dollar will get pounded lower.

Now might be a great time to consider put options on the Aussie. Here’s a more detailed look at why…

The economy is in trouble and sinking fast. From the Financial Times “The deterioration of the country’s terms of trade is crunching national income.

Recession now seems a formality: Growth last quarter, at 10 basis points, was the weakest in eight years. Households and farms are over-borrowed, and companies are even worse. Their financing requirement blew out to an all-time high last year of almost 8% of output.

With debt hard to come by, companies have three choices: Stop spending, raise equity or go broke,” according the Financial Times.

And the fact that Australia’s current account deficit is already the highest among the major currencies, estimated at 4.8% of 2008 gross domestic product (GDP), makes the currency vulnerable. (Note: the U.S. current account is estimated at 4.5% of GDP, but players have to hold U.S. dollars in order to transact trade and capital flow. They do NOT have to hold Australian dollars.)

China’s “Hard Landing” Will Clobber Australia: Not too long ago, China was everybody’s darling economy. But the crowd of China cheerleaders may be in for a very big surprise – a hard economic landing! Already Australia is suffering from the Chinese slowdown, but the probability that it will get much worse is rising fast as China’s growth numbers continue to fade.

“The one-time engine of global economic growth has been sputtering as a result of dented global demand for exports and over-zealous tightening policy at home. A hard landing, like recession, adds new fear to the mix. With shares and real estate worth sharply less, unemployment rising and deflation round the corner, companies and households are already reluctant spenders; household savings deposits rose by more than 20% in the year to November,” is how the Financial Times recently summed up the rising problems facing China.

As China goes, so goes the demand for commodities and the source of Australia’s growth. China’s troubles are the key reason I believe commodity prices have further to fall. And looking at a long-term chart of the Commodities Index, I think it will revisit 2001 territory – the year commodities prices blasted off.
Commodities Index vs. Australian $ Weekly-Round Trip to 2001!

AUDUSD Cliff Diving Chart

Aussie yield support could fade fast. Australia has been a great place to park money during the past seven years. The country was growing along with commodities, and the Reserve Bank of Australia kept their rates high to rein in inflation during this boom period.

The Aussie dollar has been the highest yielding of all the major currencies for many years, and still is. But the rapid deterioration in Aussie growth and the fact that governments are fighting deflation, not inflation, leads me to believe Australia’s central bank will hack much more off its official policy rate, which now stands at 4.25%.

I am not sure how far the RBA will cut rates, but I do believe the bank will aggressively cut rates. When they’re done cutting rates, the high yield differential that created such a seeming “no-brainer” demand for Aussie dollars will be gone.

When that happens, the Australian dollar should accelerate to the downside.

Bottom line: Australia’s growth should soon go into negative territory. The country’s already ugly current account deficit should grow worse. Australia’s key customer – China – will likely be buying a lot fewer commodities. At the same time, the Reserve Bank of Australia will likely cut interest rates much faster than now expected in an effort to generate growth.

All of this is bad news for the Aussie over the next several months.

Source: That Sinking Feeling Down Under

This from The Sovereign Society:

If you want to know how far this recession has stretched, look no further than China.

Up through this year’s Olympics, China seemed to be well on her way to becoming the next global economic kingpin. And with good reason.

China has had the fastest growing economy in the world for decades. The Chinese government has amassed trillions in reserves, while building up a trade surplus just last year of US$262.2 billion.

But lately, China’s fundamentals have been breaking down, one by one, like massive dominoes…

• Manufacturing in China just shrank by its largest margin EVER.
• China’s GDP growth for next year is projected to be around 7.5% – that’s down from an 11.5% pace not long ago.
• China recently adopted its own US$586 billion stimulus plan to try to jumpstart growth. (Notice: That’s more than twice China’s trade surplus of last year – it’s also nearly as much as the U.S. plans to spend on its US$700 Billion TARP bailout plan.)
• Housing prices are dropping in Shanghai, Shenzhen and Guangzhou.
• The central bank just slashed rates by the most in 11 years.

These dominoes are knocking down more than just China’s economy…

In fact, trouble in China spells disaster for the rest of the global economy. Specifically, a slowing Chinese economy is a dangerous situation for the United States, its surrounding Asian neighbors, over-exposed and over-indebted developed economies.

Global Manufacturing Clearinghouse Hits the Skids

You can trace all China’s problems back to their now broken export model. For years, China has played the middleman between Asia and the United States.

Their low-cost, cheap-labor production model dictated that they grab input products and other raw materials from nearby developing nations.

The Chinese then used those low-cost resources to build their goods and ship them off to the U.S. and other developed nations. China’s Asian neighbors depended on China to continue this cycle to fuel their own export-driven economies.

As a result of receding liquidity, U.S. consumers (and others) have a shrinking appetite for cheap goods, so they spend even less.

So, China is now losing its best customer, the U.S., thanks to the recession. It is also selling less to other developed nations of the world. This hurts all the emerging Asian economies that depend on China to buy their inputs. It’s a vicious cycle.

Emerging Market Currencies Will Be Hit the Hardest

In short, global capital flow has stopped dead in its tracks. And global demand is drying up. So it’s easy to see why emerging economies’ stocks and their currencies are being hit the hardest.

This is the worst possible environment for emerging economies because they depend on sustained global demand, more so than internal demand. When global capital flows dry up, these emerging economies struggle to make ends meet.

And any developed nations (and their currencies) that have exposure to these struggling emerging markets will ALSO suffer.

This includes several key European countries whose banks are over-exposed on loans to emerging markets and suffocating on massive liabilities. And this includes the euro and pound.

Just as China was vital to the boom, it is critical to the bust. And when that happens, a few currency investors who saw this coming will be in the best position to profit off this global realignment.

But there is no “One-Market” solution to play China’s bust!

Source: Why China Can’t Save the Global Economy

That said, China’s economy is still on track to post impressive growth during a global financial crisis. Unfortunately, this growth won’t meet initial forecasts.

In its latest quarterly report, the World Bank revised China’s growth downward to 7.5% from an earlier projection of 9.2%. The change reflects the World Bank’s view that Beijing isn’t doing enough to shift the country’s reliance away from waning exports to more robust domestic growth.

The Chinese economy grew by 11.9% 2007, in what appears to be the peak in double-digit expansion since 2002. Now facing single-digit prospects in 2009, China’s slower-than-expected advance call into question the global economy overall.

While most pundits see diminished U.S. consumer spending impacting China’s exports, emerging markets worldwide contributed significantly to the export boom of the past few years.

Latin America, Eastern Europe, Russia, Southeast Asia and other regions able to cash in on skyrocketing prices of fossil fuels, metals and grains are themselves suffering from the market turmoil. As commodity prices plummet, the expanding middle classes of these emerging nations begin to contract – reducing spending on consumer goods coming into their countries from China.

Reading between the lines, the World Bank also seems to be saying that the worldwide recession will be here for years to come – further hampering China’s ability to stimulate its economy.

The World Bank’s report also challenges the effectiveness of China’s new $586 billion stimulus package announced earlier this month. The package called for a massive national infrastructure build-out. Given the World Bank’s view of China’s over-reliance on exports, the new stimulus plan could ultimately prove to be a “bridge to nowhere” with no substantial growth for the long-term returns that emerging markets count on for these massive projects.

Obviously, the much ballyhooed stimulus plan isn’t enough to carry the day in China.

The latest rate cut, to 5.58% for loans and 2.52% for deposits, was the fourth cut since September.

Now, potentially like the U.S., China’s lower growth rate next year would rely heavily on higher public spending, according to the World Bank report. This could be a harbinger of how the incoming Obama administration would attempt to fix the U.S. economy based on recent news stories.

Taking into account China’s stimulus plan and other domestic projects, Beijing’s spending would add 4 percentage points in 2009 to the economy compared with 1.5 percentage points in 2007.

Another drain on China’s coffers could be subsidies for the increasing ranks of unemployed factory workers. Shrinking exports mean lower demand for products.

The government has announced new measures to support the economy, out of fear that the crisis and growing unemployment could cause increased public protests, according to AsiaNews.

Facing an epidemic of protests, Public Safety minister Meng Jianzhu warned that local regulators could face “social problems affecting stability.” In particular, there is the danger that the slowdown in exports will cause widespread unemployment.

Gunagzhou province provides a snapshot of where unemployment is heading.

A recent Chinese media report cited data from the Guangzhou Train Station, which showed in early October that the number of departing passengers compared to the same period last year had increased by 128,000.

Guangzhou is one of China’s largest manufacturing export centers.