Go “Buck Wild” with Dollar ETFs (Part 4)

11/21/2008 12:01 am EST

Focus: ETFS

By determining the why of the dollar's high times, we can better understand and predict when those high times might start to come down.

One reason for the big run in the dollar is safety.

Despite a rocky equity market here in the United States, the rest of the world has also been the victim of the equity meltdown. In fact, most global markets—and especially emerging markets—have seen a much more severe sell off than what's taken place in the US equity markets. As investors continue fleeing foreign markets, their money has kept on migrating to the stability and safety of the greenback.

In addition to the safe-haven buying we've seen in the dollar, we're also seeing depreciation in foreign currencies thanks to the recent round of interest rate cuts by central banks around the globe.

Switzerland, Canada, Sweden, the Bank of England, and the European Central Bank all cut their rates in an effort to pump liquidity into the world's financial system. An interest rate cut is usually detrimental to a currency's value because, in essence, you are making that currency cheaper by lowering the cost of borrowing.

One other factor helping to pump up the dollar's value is the unwillingness on the part of banks to lend money due to the credit crisis. And while this unwillingness to lend is generally considered a pernicious influence on the economy at large, it has had the perverse effect of shrinking the supply of US dollars in foreign markets.

Until lenders start to do what they do best and actually start loaning money, the dollar is bound to be the beneficiary of constricted supply.

For sure, all of these bullish influences on the dollar are somewhat fragile. Given the sharp rise higher in the greenback lately, I wouldn't be surprised if we see a rapid pullback before too long. Having said that, those investors who owned (UUP) for the past several months are watching their portfolios go buck wild.

Of course, when the tide turns and when the world loses its appetite for greenbacks, those holding UUP will find they have less coinage. When that happens, the simple fix is to shift your mindset and take flight into (UDN).

Finally, always remember that when it comes to making a buck, objectivity is your best friend. Get your money long the greenback while it continues running, but don't hesitate to go short when the dollar trips and falls.

By Jim Woods of OptionsZone.com

  By clicking submit, you agree to our privacy policy & terms of service.

Related Articles on ETFS