Australia is the world’s largest isolated island, particularly when you consider that West of Perth there’s nothing but the deep blue sea. But as an economic force, the Land Down Under is a formidable power. What many folks don’t realize about Australia is that it’s not quite a developed economy – it’s a fusion of an emerging market economy with a highly developed economy. That’s because Australia is largely dependent on its mining sector.

Most all the literature you read on Australia is likely to impress upon you that it is in fact a developed economy but Australia has followed the same capital inflows as BRICS nations when monetary stimulus policies were implemented in the U.S. and now more recently in Europe. China is one of the biggest consumers of raw materials in the world – and so it should be as the world’s second largest economy. But we all know what’s going on with China.

Chinese stock markets are going into meltdown, having erased trillions of dollars off equities in recent weeks. In fact Chinese equities are 40% off their June high, which is alarming by anyone’s admission. But how does this impact on Australia and more specifically the AUD? It’s simple really. When Chinese demand declines, all countries that supply China start hurting. Since the meltdown in Chinese equities, the S&P/ASX 200 index was unable to maintain buoyancy and it plunged 42.4 points to close at 5,096.9 on August 26.

Why the AUD/USD Pair is Bearish?

The fundamentals of the Australian economy are strong. However the recent 4.1% stock market decline in Australia shook the country to its very core – marking the largest single day selloff since 2009. It should be remembered that the true impact of Chinese equity weakness is limited since only 10% – 15% of Chinese households are invested in the market. The slowing GDP in China (even if we are to believe the inflated figure of 7% for 2015) is presently the lowest in a quarter century. China has been moving its economy from an export-driven paradigm to a consumer-driven economy. In my opinion, this fundamental shift in China’s macroeconomic plan is impacting on Australia in a big way.

Why do I say this?

For starters, Australia is a mining-intensive nation. It exports huge quantities to China and a downturn in commodities prices means that Australian mines are earning less revenue, layoffs are ubiquitous and many mines will likely be unable to maintain operations. Let’s not forget that the Australian mining sector comprises a large percentage of the Australian stock market. Presently over 2.2% of Australia’s workforce is involved in mining and the chief mined resources include natural gas, uranium, coal, nickel, iron ore, opal, zinc, silver, diamonds, aluminium, and others. Lower demand from China reduces the productivity and profitability of all these mining operations. With weak commodities prices, we can expect the mining industry to continue hurting for some time.

Here is how to trade the AUD/USD currency pair:

• The market looks to be oversold, but traders should be advised that the risk remains to the downside
• Look at the slope of the pair – it’s bearish and it’s trending lower
• Take out put options in the short-term although reversals are likely as clarity returns to markets

Watch Out for Uncertainty over U.S. Fed Rate Hikes

We are also seeing lots of capital flows around the world as speculators anticipate the Fed will raise interest rates before the year is out.  The correction in China’s stock market will have less of an impact on global bourses than many have expected because the problems are Chinese and there is no fundamental or structural weakness in U.S. markets, or Australian markets for that matter.

Nonetheless, the volatility has presented many opportunities for binary options traders who have been shorting the AUD/USD pair with put options of late. The general trend for the currency pair is bearish over the short-term given weak global demand. The rampant dollar is presently the currency of choice, despite slightly weaker figures on the U.S. dollar index.

I suggest that over time we should start looking at Australian services sectors and the agricultural sector as it begins feeding the growing household consumption in China. Mining may suffer in the short-term, but other sectors will invariably pick up the slack. During 2014, mining-related activity accounted for over 66% of Aussie exports to China but that figure will drop off dramatically this year. The sheer size of China’s economy will mean that reduced percentage growth may in fact still translate into bigger dollar growth for Australia. The rate of increase in China is more than compensating for the declining GDP. As a case in point, Aussie exports of iron ore to China are up 13% for the year so far.

If analysts are to be believed and their hypotheses are correct – Chinese demand for Aussie value-added production will spike by 37% by 2020. This bodes well for the long-term projection of the Land Down Under, on the proviso that China grows between 6% – 7%.