New Zealand may well be seen as a small place at the bottom end of the world where one could hide easily and hide ones cash easily. So thought Kim Dotcom and his Megaupload mates who were arrested on Friday by the FBI and NZ Police. They apparently had part of their cash holdings invested in NZ Government Bonds through an unnamed financial institution.

Whatever the merits of their copyright legal case, they must have known something about investment (or were just lucky!) Holding NZ Government Bonds, unhedged to NZD currency fluctuations, has been one stellar winning investment strategy over the past 12 months. The yield on our 10-year Government Bonds has reduced from 5.50% to 3.85% and the Kiwi has appreciated against all currencies. Plenty of capital gain on a marked-to-market revaluation basis received in that respect. Will the NZ Police sell the impounded bonds along with the marquee cars to realise the impressive gains?

Market attention this week will be centred on Governor Bollard’s view of the global and NZ economic outlook with the OCR review on Thursday. Whilst some economic data has been weaker of late and business confidence is down, Mr Bollard should not be goaded by market economists into a negative/downbeat assessment on the economy at this time, because of the following off-setting positives:-

§  Agricultural sector prices and production are both up, delivering substantial increases in rural incomes and a boom in fertiliser buying/application.

§  The Auckland residential property market is showing all the signs of a major under-supplied situation. The RBNZ do not generally ignore pressures in the housing market.

§  Business investment is on the increase, as evidenced by the Todd Energy/Methanex gas contract paving the way to an $800m methanol plant expansion in Taranaki.

§  The New Zealand economy is now more highly dependent on Australia and China and there are no signs of the so-called European “headwinds” (to use an over-used economic expression) damaging Chinese or NZ economic performance.

§  Market signals are very positive for the NZ economy with both the NZ dollar and NZ sharemarket up strongly over recent weeks. Clearly foreign investors do not see the worrying “headwinds” for our economy in 2012 that local economists are pre-occupied with and miss-guided on.

Yet again and unfortunately, the NZD/USD exchange rate trading above 0.8000 is a major constraint on achieving +3.00% GDP growth this year. Governor Bollard may well attempt to jawbone the currency down with the OCR review on Thursday. However, the currency is seemingly the only “headwind” I see restricting positive economic growth this year.

NEW ZEALAND DOLLAR MARKET COMMENTARY

The year of the Dragon and the Kiwi dollar

The movements of the NZD/USD exchange rate through December and January provide a poignant pointer as to where New Zealand’s future economic fortunes lie. Instead of following the EUR/USD rate in daily direction, as has been the norm for a number of years, the Kiwi dollar de-linked from the Euro and was pushed higher due to stronger than expected Chinese economic data (PMI, industrial production and GDP figures). The breaking of the Euro nexus has resulted in the NZD/EUR cross-rate jumping higher to 0.6250, as the NZD strengthened over a period the Euro weakened against the USD. It is entirely natural and to be expected that the NZ dollar and the NZ economy are much more influenced by and dependent upon economic news, events and trends out of China, than the economic woes in Europe.

Assisting the NZD to post strong gains from 0.7600 to 0.8000 over the Christmas/New Year period has been a confident start to the year by Wall Street, the Dow Jones Index lifting on positive investor demand. The NZD/USD exchange rate remains highly correlated to the DJI as global investors and traders continue to see our currency as a growth/commodity story when investor sentiment is “risk-on” in the markets. The gains in US equities markets so far this year indicate a higher level of confidence that the US economy will produce stronger growth and US listed companies will improve profits. US retail and housing data indicators are also starting to improve. The improved Chinese and US economic trends tell us that the global economy is not been dragged down by the economic recession in Europe. Local economists continue to highlight the headwinds the NZ economy faces from the debt/economic problems in Europe; however they appear to be completely misreading the true situation. Europe is having very little impact on the NZ economy, economic news out of China is far more important. The gains that both the NZ dollar and the NZ sharemarket have made over recent weeks confirm where overseas observers see the direction of New Zealand going.

The growing dominance of Chinese/Asian economic events and news over the NZ exchange rate direction does however bring with it new risks and challenges. Whilst official Chinese economic data remains very positive, anecdotal evidence continues to mount that activity levels are waning in both export manufacturing and internal infrastructure build. Prominent US economist Nouriel Roubini forecasts the Chinese economy to slow considerably in 2012 with housing deflating and export growth slowing. If he is proven correct, the NZD could well be at risk over coming months from weaker than expected Chinese economic data. There is certainly a strong connection between Chinese economic data and the Australian dollar movements, and the Kiwi continues to track the AUD/USD rate closely. Australian economic data remains very mixed with generally weaker domestic trends, however still strong investment and activity in the mining/resources states. Naturally, any slowdown in demand for resources out of China is negative for that part of the Aussie economy, thus the AUD as well.

The Reserve Bank of New Zealand Official Cash Rate review this Thursday is unlikely to shed any new light on when interest rates will be required to be adjusted upwards here. Several economic forecasters are dangerously extrapolating big seasonal reductions in fruit and vegetable prices late last year as reducing overall future inflation levels and thus meaning no interest rate changes at all in 2012. The RBNZ will still be overly cautious as to what the European fiasco means for the NZ economy. Generally, local economic data has been marginally weaker over recent months. However, GDP growth for this year can still be expected to reach +3.00% as high export commodity prices and increased production in the large primary industries dominates overall economic outcomes. When the RBNZ and other local economists realise that Europe has not dragged down the US and Asia and has had very minor impact on the NZ economy, they will be hastily revising their GDP growth forecast upwards and bringing forward the timing of OCR increases. It may take those forecasters six months to reach this realisation!

All the above adds up to an even stronger NZ dollar exchange rate later in the year. In the meantime, watch the USD copper price as the current best lead-indicator for the Kiwi dollar.