Currency ETFs and Inflation

12/03/2013 9:00 am EST

Focus: ETFs

The annual rate of inflation currently stands at 1.0%; but, as any Wall Street currency trader will tell you, it's not what's happening right now that counts. And most economists see it rising over the next year or two, suggests Brian O'Connell in Wealth Daily.

Increasingly, savvy investors are turning to a surprising—yet historically effective—inflation-fighting tool: currency exchange traded funds.

This is especially true of non-US currency ETFs. With the dollar losing value against other global currencies—as the US government takes on more foreign debt—a hedge in a fund that tracks foreign currencies can keep you one step ahead of inflation—and one step closer to your investment goals.

Currency ETFs allow investors to speculate in the currency market, without the risk of investing directly in currencies, and without entering the forex market.

Like all ETFs, currency funds enable investors to invest in a single currency or basket of currencies, while still taking full advantage of fluctuations in the currency market.

The majority of US investors have their entire portfolios stocked with US companies, and thus are tied directly to the fortunes of the US dollar.

Given the precarious state of the US economy these days, currency ETFs provide US investors some much-needed exposure to non-US currencies.

Currencies are notoriously fast-moving investments. If you're not prepared to do your homework, or if you're blindsided by geopolitical events (like the crash of the Japanese economy following the earthquake and tsunami of March 2011), you might think twice before committing any cash to the currency market.

You can buy a currency ETF that focuses on a single country currency, or you can mix and match currencies within a single ETF, hoping the better performing currencies override the poorer performing ones.

There are seemingly as many currency ETFs as Baskin-Robbins has flavors of ice cream. So, to keep things simple, consider a conventional play: the PowerShares DB US Dollar Index Bullish (UUP), which tracks the performance of the US dollar against key global currencies, like the yen and the pound.

If the dollar rises, the fund goes up; when the dollar declines, the fund's value declines.

To make a contrarian play, the PowerShares DB US Dollar Index Bearish (UDN) works the opposite way: When the dollar declines, the fund fares better.

To leverage the increasingly powerful Chinese economy (the largest buyer of US debt going into 2014), kick some tires with the Wisdom Tree Chinese Yuan Fund (CYB).

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