Sunday 18/12/2011 10 AM GMT 11AM CET

While the Euro has been a fantastic down trend for us we really like the look of the Australian dollar which has also made us huge gains and is due in our view to fall a further 20 full points in the New Year.

We have been trading the short side of the Aussie since 1.080 and we have seen it fall as expected last week to test the key 1.000 level. Were now sitting just above this level now - so will the Aussie Rally or will it crash?

In our view, the Aussie Dollar if it breaks back above 1.000 could run on to test the 1.020 level (just as it did last week) but this is the most the bulls can hope for, it would become a sell into this level on falling momentum with stops behind the 1.030 level. If we stay below 1.000 the down trend will be cemented and we would expect the down trend to accelerate.

The bullish view on Australia is based on the following logic and our comments on why the logic is flawed is below.

Flawed Logic and the Reality of an Aussie Dollar Down Turn

The logic that the bulls present to justify a higher Aussie Dollar is based on Australia has a robust internal economy and that China will continue to grow but the logic in our view is flawed, lets take a look at why.

The Australian Internal Economy is Robust But

It has been fairly robust but the economy is export orientated and growth will slow up in response this this and the major problem for Australia is the situation in China its major export market and also the global economy which is set for slower growth in 2012.

China Will NOT Avoid a Hard Landing

The PBOC’s unexpected 50 bps Reserve Requirement cut on November 30th.confirming that growth has now replaced inflation as the major priority for Chinese authorities. This is based on CPI inflation fell to a 14-month low of 4.2% in November. The PPI’s even steeper fall along with early December’s falls in the price of key food items like pork point, sees the market expect the Chinese to ease rates to kick start growth.

The problem will be – China is an export nation so who are they going to sell to?

Euro zone is it's biggest market taking around 25% of all exports but of course Euro zone has huge problems. I saw a major bank which says Euro zone is in for a mild recession – no its not! It's in for a decade of recession and cannot survive in its current form and this means, China will face falling demand in Euro zone. In addition, US demand will also remain weak. China, has built its growth on cheap labour and has failed to stimulate internal demand and this will cause serious problems and so to will the huge amount of debt in China.

There are huge debts in the economy and local Government which are a reflection of - a record 17.6 trillion-Yuan ($2.8 trillion) lending spree under Premier Wen Jiabao in 2009-2010 amid the global recession. Not only is there a glut of office and housing, the debt in local government has left many projects unfinished and this debt mountain is a time bomb as the economy slows up.

Our view is China is heading for the buffers and when it hits them, Australia will be hit hard. China is the Japan of the 21^st century. In the 1990s, everyone said Japan would become the world's number 1 economy and they say that about China now but the reality is – Chinese stellar growth is at an end.

Risk Aversion

The Aussie Dollar is over valued and the over valuation has to a large extent been driven by speculation. The currency is the risk currency of choice but this position will be unwound, as the global economy contracts and commodity prices tumble. Australian interest rates will fall too and with the extreme over valuation of the currency, we would expect it to fall back to around 80.00 by the middle of next year which is a full 20 points, down from current levels.

For clues to where the Aussie Dollar may go short term. Let's take a look at the CFTC Net Traders positions. Here we need to look at speculative funds ( non commercial) and now they line up against the smart money hedgers – the commercials. Commercials are hedgers and own the cash and will only move their hedges when they start to see a currency move from fair value and we are now seeing them start to sell, as speculative funds start to buy.

Australian Dollar CFTC Net Traders

The large speculative funds love the Aussie Dollar and we sold it months ago on the pop up to 1.080 and made great profits on the downside as we traded below par. We are short again and taking any opportunity to hit the short side. Let's look at the positions and where the Aussie Dollar may go next:

AUSTRALIAN DOLLAR - CHICAGO MERCANTILE EXCHANGE Code-232741

FUTURES ONLY POSITIONS AS OF 12/13/11 |

--------------------------------------------------------------| NONREPORTABLE

NON-COMMERCIAL | COMMERCIAL | TOTAL | POSITIONS

--------------------------|-----------------|-----------------|-----------------

LONG | SHORT |SPREADS | LONG | SHORT | LONG | SHORT | LONG | SHORT

--------------------------------------------------------------------------------

(CONTRACTS OF AUD 100,000) OPEN INTEREST: 153,296

COMMITMENTS

60,132 25,703 3,963 70,313 106,719 134,408 136,385 18,888 16,911

CHANGES FROM 12/06/11 (CHANGE IN OPEN INTEREST: 10,489)

6,479 1,874 1,008 2,028 7,480 9,515 10,362 974 127

The large funds were in buying last week and hold over twice as many longs as shorts while the commercials are just starting to come in and sell heavily adding over 5,000 shorts last week alone.

The rally looks on borrowed time and we think that the Aussie is a sell on a move up to 1.020 and if we close below1.000 on Monday the down trend will be cemented. This is a choppy pair and very sensitive to investor sentiment but the long term picture points to a huge sell off.

We have made great profits trading the short side and expect more to come and see this being one of the best trends in 2012.

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