Currency Plays for the Masses

10/10/2007 12:00 am EST

Focus: ETFs

Jim Lowell

Senior Partner & Chief Investment Strategist, Adviser Investments

Jim Lowell, editor of the Forbes ETF Advisor, says a growing number of ETFs allow investors to hedge, trade, or just speculate with currencies.

Currency trading is among the most volatile, speculative, and complex moves one can make on any board. And while it really only has a place in a speculative trader’s portfolio, we do cover currency for strategic reasons: It helps us gauge the health of the underlying marketplaces and their economies.

But just as you still don’t want to drink the water of many foreign countries, so I wouldn’t ever recommend even a granular sip of currency trading in anything but an aggressive portfolio designed for the least risk-averse among us.
 
What does investing in currency markets enable you to do? First, speculate on the strength or weakness of the currency’s underlying economies. It also lets you speculate on interest rates and their consequence; our US dollar is trading at recent or historical lows relative to the euro and Canada’s dollar because, not to oversimplify things, the Federal Reserve’s rate cut basically cut the value of the dollar’s ability to return yield to its investors by 0.5% vs. other currencies whose underlying rates had remain unchanged.

You can play multiple currencies off one another, or use one or another as a hedge against where you want to stay for the long haul; you could be long US growth stocks and short the US dollar or you could be long US growth stocks and long the Canadian dollar.
 
There’s another factor to consider; according to Bloomberg, foreign exchange trading has increased 65% over the last three years, representing a record $3.2 trillion a day on average. The cause: hedge funds. Expect their volatility to make the days of George Soros’s currency plays look like a sand box.

Still game? There’s plenty of divergence among currencies and their returns—and there’s a high degree of correlation between their performance and the GDP growth rates of their underlying economies.

In the current ETF currency basket you have many currencies to choose from and which even, via the PowerShares DB G10 Currency Harvest Fund (AMEX: DBV), ostensibly does the work for you. [It] tries to take advantage of the fact that currencies associated with high interest rates tend to rise in value [relative to] those associated with low interest rates, [by buying futures on strong G10 currencies and shorting weak currencies].

The ten currencies that the index selects from include the US dollar, the euro, Japanese yen, Canadian dollar, Swiss franc, British pound, Australian dollar, New Zealand dollar, Norwegian krone, and Swedish krona. (ETFs are available in many individual currencies now—Editor.)

CurrencyShares Euro Trust (NYSE: FXE) tracks the price of the euro, the second most traded currency in the world, in US dollars. (The euro has been hitting all-time highs against the dollar recently.  DBV closed below $29 Tuesday while FXE closed above $141—Editor.)

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