GEOPOLITICAL THREATS TO 2012 TRADING

AS THE currency markets opened for trading at the start of the new year, investors remained in a party mood, bidding up the Australian dollar, after PMI readings from the region printed better than expected. China’s official PMI Manufacturing report crossed back above the 50 boom/bust level, allaying concerns that the Asian giant was heading into a recession, while the Australian AIG Manufacturing report came in above 50 for the first time in six months.

Yet, while the news from Asia stoked a rally in risk, events elsewhere cast a dark cloud over the future. In the Persian Gulf, Iran successfully fired a missile that could reach Israeli and US bases in the Middle East, taking brinkmanship to a new level, after Western powers threatened further economic sanctions in the wake of the country’s continuing nuclear program.

The latest jockeying in the Middle East may be nothing more than just another round of sabre rattling, but it does present a very serious risk to global economic growth in 2012. Furthermore, I remain sceptical that China can engineer a soft landing, as its real estate bubble continues to deflate. The decline in China’s real estate values will spill over into the country’s construction sector and will have a negative impact on the investment component of its GDP, which makes up nearly 50 per cent of the country’s economy.

On the other hand, the US economy continues to show slow but nevertheless steady improvement in demand and employment. This dynamic is setting up one of my favourite trades for 2012: short Australian dollar-Canadian dollar as a bet that North America will outperform Asia this year. Last year the trend favoured the Australian dollar, as the pair rose from Ca$0.9500 to Ca$1.0500 against the loonie. However, if Asian growth begins to slow that trade will begin to reverse in 2012 and if the standoff in the Strait of Hormuz turns violent, oil prices will surge, boosting the Canadian dollar even further. Presently, the pair continues to range quietly, but if it breaks the recent lows at Ca$1.0250, parity will soon follow, as optimism gives way to caution.