Here we go again: Protecting against a dollar drop

I would expect this current weakening to stop sooner rather than later.

By AARON KATSMAN
October 6, 2010 22:47
3 minute read.
Here we go again: Protecting against a dollar drop

Aaron Katsman 88. (photo credit: )

 
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Here we go again. After a brief respite, the dollar has again started to drop against many major currencies in the world, including the shekel. In September alone, the dollar index fell 5.3 percent and declined 8.4% over the course of the third quarter – its biggest threemonth drop since the second quarter of 2002.

Many reasons abound for the current dollar fall. The most popular one bandied about in the press is because of the threat of quantitative easing by the US Federal Reserve. Quantitative easing is a form of monetary policy that centers on increasing the money supply by creating new reserves that are typically used to buy government bonds and other assets. It is considered to be effectively printing money, therefore weakening the value of a country’s currency.

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I’m no currency trader, but I would expect this current weakening to stop sooner rather than later. After all, the major currencies that are rising against the greenback are nothing to write home about and all have their own serious fundamental issues to deal with.

Kit Juckes, chief foreign-exchange strategist at Societe Generale, said in a recent interview: “The currencies market still seems hell-bent on ignoring the sovereign credit crisis within the euro zone. It’s overly simple to say the euro is benefiting solely from expectations that the Fed, the Bank of England and the Bank of Japan are likely to engage in more quantitative easing while the European Central Bank is less inclined to do so. The euro isn’t really bullet-proof in the long term. The currency’s recent strength appears tied to perceptions that the Japanese look set to join in on quantitative easing.”

So while many analysts believe the dollar will recover somewhat, local Israeli investors with money abroad still need to take steps to hedge a potentially falling dollar. For those actually living off dollar-based investments, it’s vital to take the steps needed to protect the value of the money.

WHAT SHOULD WE DO? One solution to protect your money against a further dollar drop is to become a currency speculator. But this would require a lot of money and having to stay glued to the markets all day long to catch subtle fluctuations in one currency against another. In fact, several trillion dollars are traded in this manner every day. Until now, hedge funds and other large institutions with plenty of money to spare have almost exclusively monopolized this market.

For individual investors, on the other hand, who neither have the money, the time to trade in currencies, nor the ability to absorb the potential huge losses (currency trading is very speculative), there are some other good options available to diversify away from the dollar: • Global bond mutual fund: This is a managed portfolio of bonds that are denominated in multiple currencies, such as a basket of currencies (including the yen, the euro, Swiss franc, etc.). Such portfolios may have little exposure to the dollar. The advantage of this route is that there is a paid professional who is an expert in currencies and manages the portfolio for you. In addition, since it’s a bond portfolio, you also get monthly interest payments. However, be aware that a fund like this can also lose money and is not guaranteed.



• Currency shares exchange traded funds (ETFs): Currency Shares ETFs own a corresponding amount of a given underlying currency. The investment is basically linked to the value of the currency via the dollar.

For example, a share in the Currency Shares Euro ETF is the equivalent of owning €100. This gives investors two ways to make money: firstly, a monthly dividend is paid; secondly, investors can also profit when a given currency increases in value against the dollar. When the position is sold, the appreciated currencies eventually translate into more dollars in your account.

Keep in mind that with both of these options, if the dollar gets stronger against the world’s major currencies, you can end up losing money. While this may seem confusing, one should note that for people in Israel who may be living off their dollar savings or getting help from their parents back in the United States, it’s extremely important to protect the value of their money.

aaron@lighthousecapital.co.il Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people open investment accounts in the US.

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