Investors bracing for slower growth in China are turning to a formerly little-used currency trade: selling Australian dollars and buying Mexican pesos

Updated May 13, 2013, 7:53 p.m. ET

Currency Investors Turn to Unlikely Pair

By ERIN MCCARTHY and MATTHEW WALTER

Investors bracing for slower growth in China are turning to a formerly little-used currency trade: selling Australian dollars and buying Mexican pesos. The bet is that Australia’s economy, and its currency, will suffer as Chinese demand cools for raw materials like iron and coal. Mexico, with closer ties to the resurgent U.S. economy, is seen as more insulated if commodities prices fall.It is a pairing born out of a lack of alternatives: With interest rates near zero in most developed countries, heavily traded currencies like the dollar, euro and yen offer little or no returns. Profits are being squeezed on more traditional wagers amid a stampede into higher-yielding and riskier assets. Investors are getting more creative about what they buy and sell. In the case of the Aussie and peso, that means embracing the extra risk that comes from trading two traditionally volatile currencies against each other.

“It is a good way to express not only the relative view between Australia and Mexico, but a global macro view,” said Alessio de Longis, portfolio manager of the Oppenheimer Currency Opportunities Fund, which has $51.4 million under management. “You’re expressing a view of Asia versus North America, China versus U.S., commodities versus equities.”

Mr. de Longis has held a bearish-Aussie, bullish-peso bet for most of this year.

So far, the bet has paid off: An investor who made the trade at the start of the year would have profited from a 9% drop in the Aussie against the peso, compared with a 4% decline against the U.S. dollar, a far more common bet.

On the surface, there isn’t much tying the two currencies together: Their countries’ economies have little in common, and neither appears on the other’s list of top 10 trading partners.

However, investors said Australia and Mexico act as proxies for the diverging fortunes of their two biggest markets, China and the U.S. As China begins to pivot toward an economy that is driven more by domestic demand and less by exports and infrastructure spending, its appetite for raw materials is expected to slacken, denting the prospects for Australia’s mining-heavy economy.

At the same time, strong U.S. economic data have raised hopes that the world’s biggest economy is finally emerging from years of sluggish growth, to the benefit of Mexico.

“It’s really a rebalancing between Asia and the Americas,” said Marc Chandler, a currency strategist at Brown Brothers Harriman, who said selling the Australian dollar and buying the peso is one of his firm’s top bets for 2013.

Investors have long used the Australian dollar and the Mexican peso to gamble on their larger trade partners. China restricts trading of its currency, the yuan. The dollar’s value has fluctuated as investors attempt to predict when the Federal Reserve will end its asset-purchase program.

For most of the past decade, Australia’s reliance on China was viewed by investors as a reason to buy the country’s currency. Australia’s trade with China exploded over the past decade, with exports rising from $8.8 billion in 2001 to $77 billion in 2011. Natural resources such as iron ore and coal account for more than 80% of the country’s sales to China.

Booming resource exports helped Australia avoid a recession in 2008, and its central bank kept interest rates relatively high as other developed countries cut rates to near zero.

But mining exports have slowed in the past year, and the strong currency has hurt tourism and other industries. On May 7, the Reserve Bank of Australia cut interest rates to a record-low 2.75% and warned that the Aussie’s high value was limiting growth.

By contrast, 81% of Mexico’s exports last year were manufactured goods, with the U.S. by far its biggest market. The country’s newly elected president, Enrique Peña Nieto, has called for overhauls of the energy, telecom and banking sectors, which could pave the way for years of stable growth in an economy with a history of booms and busts.

In Mexico, “you don’t have this direct China slowdown or commodity-price slowdown impact,” said Claudia Calich, head of emerging-markets debt at Invesco, which manages $748.5 billion, including $3 billion in emerging-market debt.

Her firm expects the Australian dollar to fall in value, while it favors the Mexican peso, Peruvian sol and Nigerian naira.

Not all investors are ready to give up on the Australian dollar. Traders still hold more bullish bets than bearish ones in the futures market, though the net bet on a stronger Australian dollar has plunged about 90% in the past month, according to the Commodity Futures Trading Commission.

Jan Dehn, head of research at Ashmore Investment Management, which manages $78 billion, said his firm is betting the peso’s value will rise against the dollar rather than the Aussie. He said the higher level of debt in the U.S. will lead to a weaker dollar in the long run, while Australia’s healthier finances will allow it to maintain a stronger currency.

Still, many investors see the economic-growth outlook, rather than debt, driving currencies this year.

Ken Dickson, investment director of currencies at Standard Life Investments,SL.LN -0.12% which has $270 billion under management, is betting that the Australian dollar will slide against the Mexican peso because he thinks China’s demand for Australian exports will slow. Mexico, on the other hand, can benefit from increased demand for its manufactured goods in the U.S., he said.

“Owning that trade plays changes in the global economy quite well,” he said.