Currency Wars, Zone Wars

How to benefit from currencies' race to the bottom

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On October 23, 2010, the Group of 20 finance chiefs (G-20) agreed to “move toward more market determined exchange-rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies.” In a similar tone, Treasury Secretary Timothy Geithner, back on October 18, told a group of Silicon Valley business leaders at an event in Palo Alto, California, “It is very important for people to understand that the United States of America and no other country around the world can devalue its way to prosperity, to (be) competitive... It is not a viable, feasible strategy and we [the U.S. government] will not engage in it.”

Warning: Do not believe them. Indeed, the U.S. government will not engage in currency devaluation. However, the Federal Reserve, which is not a part of the U.S. government, is engaged in devaluing the U.S. dollar through quantitative easing. For when the Fed buys Treasury securities, they create new dollars to give to the Treasury Department in exchange for various debt issues – increasing the volume of dollars on the market, thus lowering the value of each dollar bill compared to other currencies. This, in turn, makes U.S. exports cheaper and more competitive. China is similarly active in suppressing its currency in an attempt to maintain its export stream. So if the U.S. and China take advantage of backdoors and loopholes, why should we expect other nations to make earnest efforts to refrain from currency devaluation?

Despite currency tensions, there are five currency zones that already offer retail investors attractive prospects for capital appreciation and/or dividend income through currencies, which will likely become more appealing as currency wars intensify. These zones are: Canada, Brazil/Chile, Switzerland, Australia and the Asia-Pacific region:

Canada – The Canadian dollar (loonie) vs. the U.S. dollar (greenback)

Let’s begin with the “ABCs” of commodity currencies: the Australian dollar, the Brazilian real, and the Canadian dollar – all of which countries are net exporters of energy, iron ore, wood products and beef; and collectively rich in oil, copper and sugar. To their credit, they are all reliable-source nations with stable governments; sound, open markets; and a portfolio of high-demand commodities. The CurrencyShares Canadian Dollar Trust (symbol: FXC) is up 24% from its lows of two years ago. As the greenback deteriorates through quantitative easing, the loonie should rise.

Brazil/Chile – The Brazilian real vs. the U.S. dollar

For capital appreciation, the WisdomTree Dreyfus Brazilian Real Fund (BZF) seeks to achieve total returns reflective of both money market rates in Brazil available to foreign investors and changes in value of the Brazilian real relative to the U.S. dollar. As the U.S. dollar declines, the currency of this self-sufficient nation will climb.

In addition, the Aberdeen Chile Fund (CH), which closely follows BZF, pays an 8% dividend yield. Add a percentage of UUP (PowerShares DB US Dollar Index Bullish) as insurance against CH decline, as UUP generally moves inverse to CH. A one-to-one value relationship would together provide maximum capital-preservation protection while delivering dividend income.

Switzerland – The Swiss franc (swissy) vs. the U.S. dollar

The Swiss franc has long been considered a safe-haven currency due to the fact that Switzerland has one of the most stable economies in the world, a historic banking system, and sizable gold reserves. Moreover, Swiss companies such as Novartis AG (healthcare), Nestle S.A. (food & beverage), Roche Holdings AG (pharmaceuticals & diagnostics), Credit Suisse Group and UBS AG (both, financial services) are at the top of their respective class. It can therefore be reasonably assumed that the CurrencyShares Swiss Franc Trust (FXF) will continue to do well against a weakening dollar.

Australia – The Australian dollar (aussie) vs. the U.S. dollar

As you may recall, Australia emerged from the global credit crisis unscathed – suffering no loss in economic growth. With its hot export market, the CurrencyShares Australian Dollar Trust (FXA) is set for further gains against the U.S. dollar; and the 3% dividend yield of FXA is icing on the cake. Not to mention, if Singapore Exchange Ltd succeeds in its purchase of ASX Ltd (Australia’s main stock exchange), it will create a powerhouse of a commodity-based exchange that may well outshine U.S. exchanges by attracting high-value commodity-related listings.

Asia-Pacific vs. the U.S. dollar

As a dividend income play, the ING Asia-Pacific High Dividend Fund (IAE) pays a 9% dividend yield and consists of a range of sectors from the following countries (as of May 31, 2010): Australia (26%), Hong Kong (15%), South Korea (13%), China (12%), Taiwan (11%) and India (6%), to name a few. As the U.S. dollar is diluted, the dividend payout for ING becomes easier to make in dollar terms.

There is more to share, but brevity is prudent. A strategic allocation of such investment vehicles would provide the opportunity for capital appreciation, wealth preservation, dividend income and global diversification. The risk is that U.S.-dollar currency wars against these zones may produce currency clones of proliferating greenbacks. Before investing, please know that currency direction is highly subject to geo-political forces; and that dividends can be increased, decreased or eliminated at Fund discretion. Therefore, do your own research, giving careful consideration to your risk tolerance.

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About Tony Richardson