Protect Yourself Against a Falling Dollar

10/27/2009 1:00 pm EST

Focus: STOCKS

Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, says the greenback will continue to slide for years, and recommends stocks, mutual funds, and ETFs to hedge that risk.

[Why is] the dollar going to keep falling against foreign currencies?

1. The Obama administration wants a weaker dollar because it helps the economy by increasing foreign demand for US goods.

2.  Investors are skittish about government borrowing. The Obama administration is spending hundreds of billions of dollars to rescue banks and stimulate the economy, [while] the Federal Reserve is "monetizing" the national debt—using government money to buy government debt as another way to inject dollars into the system. Over the long term, these policies are a recipe for ruining a currency

3. Interest rates are low in the US compared with the rest of the world. This hurts the dollar in two ways: Investors take their money elsewhere to get higher rates, [and] in what's known as the carry trade, investors borrow in the US at cheap rates to invest elsewhere. This creates an excess supply of dollars as those investors sell borrowed dollars to invest elsewhere.

Of course, the dollar will bounce around, but overall, the above factors spell doom for the dollar for several years ahead. Here are the best ways for investors to play this trend:

1. Buy foreign currencies [by investing] in foreign-currency mutual funds playing the weaker dollar trend, [such as] Merk Hard Currency fund (MERKX. Another option is to go with foreign-currency exchange traded funds such as CurrencyShares Euro Trust (NYSEArca: FXE), CurrencyShares Australian Dollar Trust (NYSEArca: FXA), and WisdomTree Dreyfus Emerging Currency (NYSEArca: CEW).

2. Buy precious metals and other commodities. You can get exposure to gold and precious metals through ETFs or exchange traded notes such as SPDR Gold Shares (NYSEArca: GLD),  iShares COMEX Gold Trust (NYSEArca: IAU), iShares Silver Trust (NYSEArca: SLV) or ELEMENTS Rogers International Commodity Index Total Return ETN (NYSEArca: RJI).

3. Buy companies doing business overseas. Companies making their stuff in the US will see demand increase because of a weakening dollar. And companies that produce abroad can buy more greenbacks when they bring their earnings home.

Some classic plays on this theme are Coca-Cola (NYSE: KO), PepsiCo (NYSE: PEP), McDonald's (NYSE: MCD), Johnson & Johnson (NYSE: JNJ), [and] Procter & Gamble (NYSE: PG).

4. Buy bond funds that park money abroad. When you invest in foreign bonds that do not hedge away the currency risk, you're "parking" money abroad. As the local currencies get stronger against a falling dollar, that parked money can buy more dollars, so wealth goes up. Plus the interest rates their money earns abroad will likely be higher than it would earn here.

Any global bond fund that doesn't hedge away currency risk can be used to play this strategy. Arijit Dutta of Morningstar says three of them are the Pimco Foreign Bond Fund (Unhedged) (PFBDX), the Pimco Global Bond Fund (Unhedged) D (PGBDX), and the Templeton Global Bond Fund A (TPINX).

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