The world of exchange-traded funds abounds with investments that can help you profit from the greenback's sudden rebound.
By Tim Middleton
The U.S. dollar is soaring in value, and investors who are playing the move are raking in huge gains.
Since lows of early spring, the dollar has gained 8.7% against the euro, 9.1% against the British pound sterling and 12.9% against the Japanese yen.
Aggressive investors can do much better. The Market Vectors Double Short Euro ETN (DRR, news, msgs), for example, has spurted 14.3% in the month ended Aug. 26, making it the third-best-performing exchange-traded fund in the MSN Money database.
The second-best performer, UltraShort MSCI EAFE ProShares (EFU, news, msgs), surged 14.6% in the same period, with almost all of the gain due to weaker foreign currencies. The top performer, PowerShares DB Gold Double Short ETN (DZZ, news, msgs), powered up 24.6% as traders dumped gold for the currency it is known to hedge, the greenback.
The dollar is still down longer term -- 40% against the euro, for example. But that means that if you believe as I do that the trend has reversed, there's a lot of room for the dollar to move up -- and for investors to cash in.
Further gains seem likely. While the United States clings to positive growth -- revised to a gain of 3.3% in the second quarter -- Germany, the biggest euro-zone economy, suffered negative growth in the same quarter, and Great Britain is not far behind.
The biggest threat to U.S. growth, meanwhile, has abated as commodity prices have tumbled -- for us much more than for the rest of the world. Like gold, oil and grains are widely seen as beneficiaries of dollar weakness; their prices rise when the dollar falls, and those prices are the dollar's victims when it strengthens.
The world's largest economy, our own, will get the lion's share of the cost savings that come with cheaper raw materials.
Half a dozen ETFs offer particular potential for exploiting the dollar's sudden strength. One or more of them could help erase some of the considerable losses we investors have experienced throughout our portfolios over the past year or two.
Dollar's rise takes toll overseas
Almost universally and, in one case, surprisingly, overseas stocks have taken a beating with the dollar's rise.
The mighty Chinese renminbi -- whose value is arbitrarily set by the government, not traders -- has resisted the currency trend, rising 6.8% against the dollar this year, as of last week. But international investors have shrugged off the renminbi's manipulation and sold Chinese stocks along with other foreign equities.
In the past month, iShares FTSE/Xinhua China 25 (FXI, news, msgs) is down 7.8%. SPDR S&P 500 (SPY, news, msgs), the investable form of the index traded on the U.S. stock market, is actually ahead 1.6%.
iShares MSCI EAFE Index (EFA, news, msgs), which represents foreign developed markets, is down 6.8% in the past month. UltraShort MSCI EAFE ProShares, which I mentioned above, tracks the same index but is a leverage fund designed to go up twice as much as the EAFE index goes down.
I recently advised subscribers to my newsletter, ETF Insider, to buy the UltraShort EAFE fund, and I intend to buy it myself three days after this column appears, in accordance with MSN Money policy.
As the trend turns
Currency trends can be lengthy affairs. The euro's gain against the dollar between 2001 and this year reversed a decline of similar magnitude in the prior seven years.
As I explained in a column two weeks ago, foreign developed-market stocks have gotten all their gains in this decade from the dollar's weakness. When the buck turns bullish, those stocks become an albatross for U.S. investors.
Playing this trend as an investor could involve dabbling in some new areas.
Market Vectors Double Short Euro ETN, for example, is another leveraged fund that tries to double the numbers of the index it tracks. And the "ETN" in the name stands for exchange-traded note. Whereas ETFs own securities, including futures and options, ETNs amount to a bank-guaranteed return based on an index.
For this reason, ETNs are subject to the risk that the credit rating of the issuing bank will turn sour. Last year, when Bear Stearns collapsed, an ETN tied to it, BearLinx Alerian MLP Select Index ETN (BSR, news, msgs), was briefly buffeted in trading. It recovered as Bear Stearns was bailed out through public and private intervention.
PowerShares DB Gold Double Short ETN, similarly, represents bank debt rather than physical securities. But even amid today's financial meltdown ETNs have held up well.
There are at least three other ways to play a burgeoning buck:
- PowerShares DB US Dollar Index Bullish (UUP, news, msgs), ahead 5.9% in the past month, invests in futures tied to the dollar's performance against the big three foreign currencies, plus the Canadian dollar, the Swedish krona and the Swiss franc.
- PowerShares DB Commodity Double Short ETN (DEE, news, msgs), ahead 11%, is a leveraged bet against crude oil, heating oil, gold, aluminum, corn and wheat. Nearly all commodities trade in U.S. dollars, and the global bull market in commodities in recent years was fueled partly by the greenback's weakness.
- Ultra S&P Small Cap 600 ProShares (SAA, news, msgs), up 3.9%, is a leveraged vote for small companies, which depend far less than giant firms on foreign sales. A rising dollar actually hurts multinational companies, whose products become less competitive at the same time the value of their foreign earnings declines.
The trouble with currency trading
All of these pro-dollar investments are likely to be much more volatile than the stuff most of us own in our brokerage and retirement accounts. The simplest way to take advantage of the dollar's advance is to cut back on foreign developed-market stock funds and bulk up on small-cap and midcap funds.
One of the most pleasant prospects of a rising dollar is that foreign travel will become more affordable. When my wife and I were in London some months ago, we remarked that many, many prices were identical to those in New York City -- except they were denominated in pounds, which cost us $2 each.
Accordingly, I did not pick up that Savile Row suit that is on my perpetual wish list. I reasoned its price would come down some day. Already the sale is beginning.
At the time of publication, Tim Middleton did not own any securities mentioned in this article.