Mark Lister: Count the blessings of a strong currency

Opinion

The New Zealand dollar has been astoundingly strong lately and is sitting just below its all-time highs at around US82c. Since floating in March 1985, the dollar has averaged US60c. So at US82c it's about 36 per cent above that historic average.

The reasons for this strength are as much about the problems that many other countries are experiencing as they are about what is happening here at home.

The United States has a horrendous budget deficit, high levels of debt and a housing market that people are still not completely sure has reached the bottom.

New Zealand is in relatively better shape. We have an economy based on agricultural products that are in strong demand, and we are next door to an economy that is equally blessed with a resources-rich mining sector. We are a relatively safe option given the woes of parts of Europe and the ongoing issues in the US.

Our Reserve Bank is seen as credible, our Government sensible, and our outlook better than most in the eyes of many global investors. We also have quite attractive interest rates, with our OCR of 2.5 per cent being relatively more attractive than the equivalent 0.25 per cent in the US and 0.5 per cent in Britain.

Australia is one of the few countries with a higher cash rate, at 4.75 per cent, and that is one reason why our dollar is buying only A76c Australian dollars, below the long-term average of around A83c.

Although we seem overvalued against most currencies across the world, compared with Australia we appear undervalued. The first thing we should remember is that it's not all bad to have a strong currency - it's something of a vote of confidence.

One of the best analogies I've heard is to think of a currency like the share price of a country. When your prospects are good, your balance sheet is stable, and there is demand for your goods and services, your share price (in this case, the kiwi) goes up.

Our spending power is much improved and anyone travelling overseas or buying imported goods benefits from a high currency. At the very least we are paying much less for our petrol than we would be if the currency was back at US60c.

On the negative side, our export sector suffers when it comes to a high currency, although not all exporters are affected so badly. Fonterra's recently upgraded forecast payout range highlights how strong the underlying demand for dairy commodities is, and this record payout comes at a time when we also have a record high currency.

The underlying commodity prices have been so strong they have more than offset the rising exchange rate. In fact, the strong demand and rising prices for these commodities are large drivers of the high New Zealand dollar.

The fortunes of our economy are intrinsically linked to the performance of the agricultural sector and a collapse in prices for these commodities would see the currency fall as a result. This provides a much-needed shock absorber for the country, as the weaker prices for our products would be offset by a more favourable exchange rate.

For the manufacturing and tourism sectors, the high currency is more of a problem, as they haven't had the same corresponding increase in the value of the products they sell. Luckily, our largest trading partner is Australia, which takes about 20 per cent of our exports, where our currency is at historic lows.

While most commentators recognise the potential for momentum to carry the currency higher in the short-term, the general consensus among the major banks is that the kiwi will fall to around US74c by the end of this year, then weaken further to US72c by the end of next year.

This would represent a fall of about 13 per cent, although it would still see the dollar trading well above its historic average.

Against the UK pound the average forecast suggests a decline of a similar magnitude from 50p to 43p by the end of next year. Our currency is expected to trend back towards its long-term average of A83c against the Australian dollar over the next three years, a rise of about 8 per cent.

Currency forecasts change regularly and are often inaccurate. But taking a step back from the short-term noise of financial markets, there is a case for taking advantage of the high New Zealand dollar and adding some global shares to investment portfolios.

Given the unusually weak exchange rate against the Australian dollar, it could also make some sense to sell a few Australian shares to fund these purchases. To reduce some of the timing risk, we would suggest buying in instalments.

That way if the currency goes even higher some of these purchases would take advantage of the even higher exchange rate. The US remains the largest economy in the world and has the most open, business-friendly policy settings of any developed economy.

This, together with its technology prowess, highly developed property rights, access to capital and immense scale give it serious competitive advantages over both developed and developing economies.

Higher interest rates could also support a recovery in the greenback. When the US starts to increase interest rates (which may be within the next 12 months) from effectively zero, or even just starts talking about the possibility of doing so, we could see the prospect of these higher rates boost demand for the US dollar.

The US dollar is still seen as a safe haven, and is still the world's reserve currency.

This reserve currency status may diminish over time as investors diversify away from the US dollar, but it is likely that it will still have a place. Despite the obvious concerns about the US budget deficit and debt levels, investors still return to the greenback at the first sign of risk.

And while there are signs that the Chinese are considering raising the value of the yuan, this will be a gradual process, and it will be positive for American exporters and help rebalance the US economy.

Perhaps most importantly, when compared to the rest of the world, our market is tiny, accounting for a mere 0.07 per cent of the total value of world markets.

The US remains the largest, at about 30 per cent, followed by Asia including Japan (about 29 per cent) and the UK and Europe (about 25 per cent). Even the Australian market, which is 40 times larger than ours, is relatively small on a global scale at just 2.9 per cent.

Many companies in the US and UK are exporters, with a large proportion of their earnings coming from Asia, Europe and Latin America. Nearly 50 per cent of the combined revenues from companies on the US market come from outside the US.

They have benefited from a weak currency and this has been a key driver of recent profit growth. This gives investors something of a natural hedge, because should the US dollar and the pound remain weak, those companies will benefit from higher export earnings.

It doesn't take much to dent a small, vulnerable economy such as ours. All it takes is some sort of one-off shock, such as a natural disaster, or a disease affecting our agricultural sector, or a relapse of some of the concerns that led to the global financial crisis. So it makes some sense to have a portion of your savings invested outside the country, and it could well be a good time to begin implementing a plan.

* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice. Craigs Investment Partners invests in all of the companies mentioned on behalf of its clients.