What can U.S. residents do to protect their hard-earned savings from the ravages of further asset price inflation? The Loonie is worth more than a Greenback? Can there be any stronger statement to show the decline of the U.S. Dollar than that the value of the Canadian Dollar has exceeded the American one for the first time in 30 years? Thanks to the unlimited variety of security derivatives, you have many choices to diversify from your arm-chair without traveling to far-flung placesalthough there is something to be said about traveling to far-flung places and making it a tax deduction. Here’s a cross-section of possibilities.
For a conservative holding EverBank World Markets (http://www.EverBank.com) offers bank accounts and certificates of deposit (CD) denominated in various foreign currencies. Even if you do not keep a long-term investment there, you can use the account to transfer funds for asset purchases in foreign countries. EverBank can wire money in various currencies, and they do the currency exchange at 0.75% or less over the spot market price. This can save you money compared to the usual 3% spread that U.S. or foreign banks charge. If you send U.S. Dollars, the receiving bank charges that spread when they do the exchange. To keep up-to-date on foreign currencies, you can subscribe to EverBank’s daily e-zine at http://www.dailypfennig.com. For more flexibility, check with an international brokerage like Charles Schwab (http://www.Schwab.com). Their international desk can wire funds in 14 different currencies and do the exchange at rates similar to EverBank.
Instead of CDs you can buy securities that track currencies. The exchange-traded funds (ETFs) of the Rydex CurrencyShares family (http://www.currencyshares.com) trade like regular stock. They invest their funds in foreign currencies and pass the interest on to you as dividends. Among the more popular ones are the Euro Trust (ticker symbol: FXE) and the Australian Dollar Trust (FXA). They track the movements of their respective currencies within about 1%. You pay your broker’s standard commission for stock trades as you buy and sell, but since the funds do not actually exchange your money for foreign currency, there is no exchange spread. If you prefer European-style cash-settled options on indexes, you can use the Philadelphia Stock Exchange World Currency Options (http://www.phlx.com/market/WorldCurrencyOptions.asp), e.g. Euro (XDE) or Yen (XDN).
If you want more leverage to speculate in currencies, you can open a futures account to trade directly in currency futures. Keep in mind, though, that you are trading against big banks including central banks with deep pockets. If they decide to push a currency in a particular direction, and you are on the wrong side, it could prove an expensive lesson. For more flexibility try a brokerage like thinkorswim (https://www.thinkorswim.com) that allows you to trade currencies as a sub-account of your brokerage account. That way you can move money between stocks and currencies as you see fit.
Gold and Oil
No discussion of Dollar hedging would be complete without “hard” assets, especially gold and oil, where most of the world-wide trading is done in Dollars. Hence, as the Dollar drops, those commodities tend to rise. Rather than have gold bullion or barrels of oil at home, you can speculate in futures. There are also ETFs such as streetTRACKS Gold Shares (ticker symbol: GLD) and United States Oil (USO) that you can buy through a regular brokerage account. For added leverage you can also use ETFs such as Market Vectors Gold Miners ETF (GDX) or open-ended mutual funds available through various companies that invest in mining or oil companies, or even individual stocks of resources companies. These do not track the commodity directly, though, and may produce unexpected results. For instance, gold mining is an energy intensive business. If the price of both gold and oil rise, miners make more selling their gold, but also pay more to mine it. The small size of the gold market can lead to wild price swings as major institutions enter or exit. Integrated oil companies produce oil, but also refine and sell it as gasoline at their stations. Their profits are determined by so many different aspects of the business that a rising oil price may not improve the bottom line. Oil prices also tend to be in contango. You should not trade oil as a commodity, including through USO shares, until you understand the impact of this skew in oil futures prices over time. Seeing the need for a conservative investment choice EverBank offers precious metal CDs. The terms are quite different from cash CDs, so check with EverBank before investing.
Then there is the “hardest” of assets, namely real estate. There are many overseas markets, such as my favorite Berlin, Germany, or various areas in Eastern Europe, that did not participate in the world-wide real estate bubbles. As real estate is denominated in the local currency, it can act as a hedge against a Dollar drop. The actual market price, of course, fluctuates for many other reasons, so the hedge is not perfect. If you do not want to deal with managing real estate from a distance real estate investment trusts (REITs) and open-ended international real estate mutual funds that trade in the U.S.A. provide an alternative. Keep in mind, though, that many foreign markets such as London or Madrid have seen price gains bigger than even the hot U.S. areas. Prices in some of these cities have started to retreat.
You can also indirectly hedge the dollar with stocks of companies that do a good part or all of their business in a strong foreign currency. The hedge is obviously better the more of the business is overseas. While most large American companies such as Coca-Cola (ticker symbol: KO) or Microsoft (MSFT) have about half of their business outside the U.S.A., there are many purer plays such as Volkswagen AG (VLKAF) or Vimpel-Communications (VIP) that trade on U.S. exchanges. You can get a blend of currency and hard-asset hedging with shares of overseas mining and oil companies such as BHP Billiton Ltd (BHP) or Petrobras Energia (PZE). Like any stock these move up and down with the fortunes of the underlying companies, thus bad news can undo your hedge. To mitigate some of the risk you can pick ETFs or mutual funds that invest primarily in overseas companies, such as iShares MSCI Brazil Index (EWZ) or iShares MSCI Canada Index (EWC). As Thailand showed recently, though, news like a military coup can tank the stock market of an entire country.
You may notice the absence of Asian economies such as Japan and China. They “manage” their currencies to fall with the U.S. Dollar, thus provide little of a currency hedge. That explosive growth in Chinese stocks masks the underlying currency weakness is another story entirely. As Former Federal Reserve Chairman Alan Greenspan opines, the Chinese market is in a bubble. If these countries decide to let their currencies appreciate, however, they could move massively against the Dollar to make up lost ground. Rumor has it that billionaire investor Warren Buffett’s big currency bet is in the undervalued Japanese Yen. You may have to have patience, though, as the Yen has been essentially flat against the Dollar over the last few years despite swings of roughly 10% in both directions.
You have to also consider that the obvious candidates overseas have been known for a long time and prices have been bid up. For example, EWZ and BHP have more than doubled over the last two years, thus far outrunning the gains from exchange rates alone. You may be buying at the high of the stock price and suffer losses, even if the currency continues to advance. As they say in the investing world, past performance is no guarantee of future results.
This brings us to the last choice for hedging the dollar, namely doing nothing in anticipation of a Dollar rise. Many people believe the dollar has reached bottom against overvalued currencies such as the Euro and will reverse course. In addition, there could be another counter-trend rally. During 2005 the Dollar rose over 10% against the Euro while the Federal Reserve aggressively raised interest rates, one of the key supports of a currency. The Euro has taken back all that gain since, but there are arguments for a Dollar rise, just as there are arguments for a continued drop. That is the beauty of investment opinions: so many different ones to choose from. I can guarantee you, though, that one of the choices above will be right in the end.
October 13, 2007, Updated January 27, 2008