How to Diversify Out Of U.S. Dollars With ETFs

By: Ron_Rowland

Do you pay attention to the currency markets? You’d better, if you want to survive and thrive in these crazy times.

I have to tell you I am NOT a currency expert. For deeper analysis I refer you to my Money and Markets colleague Bryan Rich. I do, however, know a trend when I see one — and right now the trend in the U.S. dollar is down against every major currency.

The U.S. Dollar Index measures the greenback’s change against a basket of other currencies. From its most recent peak on June 7, 2010 through October 12, the index fell 12.8 percent. Wow!

Investors have many ways to play the foreign exchange markets, including futures contracts. But I think exchange traded funds (ETFs) are ideal for most people. So today I’ll tell you about some that are capturing the dollar’s downturn.

First, let’s look at the big picture …

Obama and Bernanke Want a Cheaper Dollar!

If you’re a logical thinker, you might wonder what possible advantage could there be in wanting your own currency to lose value. Financial markets aren’t always logical. So let me give you a quick explanation on how foreign exchange rates work.

The key is trade. All international transactions have to be settled somehow. For instance, when you buy a Japanese car your dollars somehow must find their way back to Japan and converted into yen.

The U.S. imports more than it exports.

This wouldn’t be a problem if nations always imported and exported the same amounts. They don’t. We here in the United States buy more stuff from overseas than they buy from us. This is good in some ways, but it’s also a political problem. Why? The resulting domestic unemployment makes people want to vote against whoever is in power at the time.

Consequently, presidents from both parties have long wanted to cheapen the dollar. Ditto for the economists those same presidents appoint to the Federal Reserve Board. The reason for this is because a cheaper dollar makes U.S. goods more affordable to foreign buyers and increases our exports, thereby creating jobs and keeping voters happy.

Neither the president nor the Fed determines how much a dollar is worth. They can, however, do things that make a short-term difference. That’s what is happening right now:

• Congress and the Obama Administration are racking up huge deficit spending, while …
• Ben Bernanke’s Federal Reserve is planning a second round of “quantitative easing” to create more dollars out of thin air.

Both of these policies are negative for the greenback — and my guess is they aren’t going to change any time soon.

The Fed is driving the dollar down.

Meanwhile, other governments and central banks — in China, Japan, Europe and elsewhere — are doing the same things! To protect their home economies, they’re trying to devalue their own currencies against the dollar.

Who is most likely to get their way? For now, the U.S. is in the driver’s seat. Bottom line: The greenback could have a lot farther to go on the downside.

Ride the Dollar Down With Currency ETFs

The good news is you don’t have to just sit back and take the punishment as your dollars lose purchasing power. You can defend yourself — and maybe even turn a profit — by using ETFs to bet on the falling dollar.

More than thirty currency ETFs are now available to individual U.S. investors. With these you can implement strategies that were once available only to large, sophisticated institutions.

Of course, you have to know which ETFs to buy … you can’t just throw darts and expect to survive in today’s markets. But to give you an idea of what’s available here are a few ETFs that seem to have found some mojo lately:

• ProShares Ultra Euro (ULE) is a leveraged fund that tries to deliver twice the change in the dollar/euro exchange rate. It has been flying the last few months.
• CurrencyShares Swiss Franc (FXF), CurrencyShares Swedish Krona (FXS), and CurrencyShares Australian Dollar (FXA) each focus on a single foreign currency, and all three have posted double-digit returns since June. So has WisdomTree Dreyfus South African Rand (SZR).
• PowerShares DB U.S. Dollar Bear (UDN) is a basket of foreign currencies in an ETF that tracks the inverse of U.S. Dollar Index I mentioned above. UDN is a less aggressive bet against the dollar because it reflects the performance of several different currencies instead of just one. This diversification is a good idea if you aren’t sure exactly which currencies will perform best against the dollar.

And here are the returns for the above from June 7, 2010 through Oct 12:

Take care if you buy any of these ETFs. They can be volatile from day to day, despite the dollar’s long-term trend. Check the trading volume and use a limit order.

Best wishes,

Ron

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