Currency markets were largely off-limits to individual investors until just a few years ago, and many investors lack familiarity with the mechanics of these seemingly opaque and complex markets. What makes a currency strong or weak? Is a strong dollar “good” or “bad” for investors? Which sectors thrive in a rising dollar environment? A falling one? Fidelity Independent Adviser’s ETF Report tackles these questions in the latest issue of their newsletter—released today—in an effort to clarify the cloudy waters of currency trading.
For most investors who keep tabs on market trends, it’s no secret that the U.S. dollar has had a tumultuous year. On July 15, for instance, the venerable greenback sank to an all-time low against the euro, the currency of the 15-nation Eurozone. On that day, you would have received a little less than two-thirds of a euro in exchange for your dollar. That was a far cry from October 2000, when the dollar fetched a record €1.20. Over the summer, the dollar experienced similar slumps against other widely traded major currencies, including the British pound.
More recently, however, the dollar has experienced a dramatic reversal of fortune, as the economies of Europe and Asia weather the same economic storm that first hit the U.S. last year. Is the dollar just bouncing off its summertime lows, or is this rebound the beginning of a new upward trend?
“There aren’t many simple answers for investors hoping to profit from movement in the currency markets,” argues Don Dion, publisher of ETF Report, “but there are some basic economic effects of a weak dollar that nearly everyone agrees on.” Dion also elaborates on the relationship between currencies and commodities: “when the dollar loses value against foreign currencies—the most widely used benchmarks are the euro, the Japanese yen and the British pound—U.S. goods become more competitive in the global marketplace. At the same time, commodities—at least those denominated in dollars—tend to rise in price.”
Why? Dion asserts that it is a simple matter of the exchange rate. In July 2008, a European customer of a U.S. machine tool manufacturer, for instance, could get nearly twice as much value for his euro as he could in October 2000—two lathes, drill presses or grinders for the price of one. The same products made by a European manufacturer would be twice as expensive for an American customer.
Dion also applies this same basic principle to commodities: “energy analysts frequently point to the currency markets as playing a role in the record run-up in oil futures earlier this year. Those contracts are priced in dollars, so when the dollar loses ground in the currency markets, it takes more dollars to buy the same amount of oil.”
In addition to suggesting that investors “take advantage of the weak dollar” by investing in companies that rely on exports, Dion also examines the foreign currency ETFs recently introduced by issuers. So how does all this help investors? Rydex and PowerShares have opened up this market to investors, with innovative products that allow investors to incorporate direct currency exposure into their portfolios.
“Most long-term investors, however, should use these funds sparingly,” Dion notes, “using a Rydex CurrencyShares fund that holds the currency of a stable and strong economy, such as the Swedish Krona Trust (FXS), to replace part of a cash position is one good way for a long-term buy-and-hold investor to take advantage of these innovative products”
As always, investors have one eye on the recent past and one eye on the future. The dollar has been gaining ground in recent weeks, but will it keep going? While several factors affect the movement of the dollar, the most important of these is probably the interest rate the Federal Reserve sets in its Federal Open Market Committee meetings every six weeks. As a general rule, higher interest rates support a strong dollar, while lower interest rates contribute to a weak dollar. The Fed began cutting rates aggressively in the second half of 2007 but has been on hold more recently. “If the economy stabilizes and employment picks up in the next several quarters, look for the Fed to begin raising the key federal funds rate from its current level of 2.0 percent—and for the dollar to continue gaining strength,” Dion concludes.
About Fidelity Independent Adviser’s ETF Report
Offering 5 ETF portfolios, the ETF Report strives to keep subscribers well-informed before making investment decisions. With more than 70,000 subscribers in the United States and 29 other countries, Fidelity Independent Adviser publishes four monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.
Publisher Don Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Massachusetts, Dion Money Management manages more than $700 million in assets for clients in 49 states and 11 countries. A licensed attorney in Massachusetts and Maine, Mr. Dion has more than 25 years’ experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.