Up and Down with the Dollar

12/15/2014 9:00 am EST

Focus: ETFs

Mark Salzinger

Editor and Publisher, The No-Load Fund Investor

Given the US dollar’s recent strength against most other currencies, we are providing a look at the most popular ETFs for making pure bets for or against the greenback, notes Mark Salzinger, The ETF Investor's Report.

PowerShares DB US Dollar Bullish (UUP) and DB US Dollar Bearish (UDN) do not invest in currencies directly. Instead, they track indexes from Deutsche Bank of futures contracts on the US Dollar Index.

The US Dollar Index measures the performance of the dollar relative to a basket of foreign currencies. Recently, the basket included the euro (about 58% of the basket value), yen (14%), pound sterling (12%), Canadian dollar (9%), Swedish krona (4%), and Swiss franc (4%).

When the value of the dollar rises against this array, the index rises—that is—it takes more of these currencies in this proportion to make up one dollar.

UUP’s index tracks the performance of long futures contracts on the US Dollar Index, meaning that when the US Dollar Index rises, the futures contracts will gain and UUP’s portfolio will increase in value.

UDN’s index tracks the performance of short positions in futures contracts on the US Dollar Index. Therefore, UDN gains when the dollar declines relative to the basket.

So far in 2014, UUP has gained 9.1%, while UDN has fallen 10.0%. Such performance seems poised to persist, given the relative strength of the US economy, which grew at a 3.9%pace in the third quarter of 2014.

Growth in the EuroZone was only 0.2% over that time, while Japan’s GDP actually shrank.

Economic strength in the US has allowed the Federal Reserve to wind down some of its most aggressive monetary stimulus (such as bond buying) at a time when weaker European economies and Japan are causing their central banks to cut rates and/or initiate monetary stimulus regimes of their own.

Pure currency plays aren’t essential components of most investors’ portfolios, which have ample exposure to foreign currency in their foreign stock holdings. However, for an investor who believes that foreign currencies will eat away at foreign stock returns, UUP is an effective hedge.

UUP also has little stock market related risk. Over the past year (through November 30, 2014), its performance has had very low correlation to moves in either the S&P 500 Index (correlation of 0.28) or the MSCI EAFE Index (correlation of 0.03).

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