We haven’t written often about relative value amongst the commodity currencies here, but it’s a topic we have given some additional thought to over the past two weeks.

We have been watching as the Australian dollar underperforms its Canadian counterpart.

Since the start of February we have seen this pair awake from its sleepy state and show some interesting volatility. On days when risk aversion rises substantially, we see the Canadian dollar outperform the AUD while on days like Tuesday, the opposite happens.

The takeaway might be that a leveraged AUD/CAD carry trade is in play. We applaud anyone who has been involved in this trade as the pair rallied from 0.77 to 0.99 and earned a reasonable amount of interest since Feb. 09.

The game looks like it is up, however, as we saw the first unwind in late December. this makes a great deal of sense, as longer-term players would be booking a year-end profit.  The trade recovered on the first trading days of the year but struggled at 0.96 and the slump last week looks like it shook out some of the longs.

We believe that levered, macro, long-term longs are involved in this trade but are growing increasingly worried. We know this about carry trades: when they unwind, they unwind fast. If we see the 200-day moving average taken out again and then see 0.9199 breached, we expect to see the pair fall further. Perhaps to 0.8992 followed by 0.8780.

We recognize, however, that if sentiment improves, this remains a very attractive carry trade with minimal volatility. In an improving economy, Australia will hold a yield advantage over Canada for the foreseeable future. If the downward sloping trendline we have drawn breaks, we will exit shorts.

On Tuesday, the pair traded in a range 0.9273 to 0.9386 as the AUD rejected support at the 200-day moving average and put in a strong rally. So far today, the pair is indecisive, trading between 0.9343 and 0.9385. Support is at 0.9312 but nothing substantial until 0.9258. Resistance is at 0.9387 and 0.9418.