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3 ETFs For Surprise Drop In The Dollar

Sumit Roy

One of the most prominent consensus calls heading into 2017 was that the U.S. dollar would head higher during the year.

Wall Street analysts were nearly unanimous in their expectation that a Donald Trump presidency would spell only good news for the greenback thanks to stronger growth expectations and higher interest rates.

As is often the case, the consensus expectation has proven to be off the mark, at least during the first part of the year. After peaking at a 14-year high late last year, the U.S. Dollar Index has steadily dropped during the first quarter of 2017, and was last trading down 3% year-to-date.

Last week's failure by Republicans to pass a health care bill through the House of Representatives was the latest setback for the buck, which had rallied four-straight years, measured by the popular U.S. Dollar Index.

Under The Dollar Index Hood

That index is heavily influenced by the euro-dollar (EUR/USD) foreign exchange rate, which has a 57.6% weighting in the index basket. That's followed by the dollar-yen (USD/JPY) at 13.6%; the pound-dollar (GBP/USD) at 11.9%; and a few others with smaller weights.

 

Currency Weight
Euro (EUR) 57.6%
Japanese Yen (JPY) 13.6%
British Pound (GBP) 11.9%
Canadian Dollar (CAD) 9.1%
Swedish Krona (SEK) 4.2%
Swiss Franc (CHF) 3.5%

 

Of course, there are plenty of other currency pairs outside of those in the U.S. Dollar Index basket. The Mexican peso, for example, is up nearly 10% against the greenback after falling to a record low around the time of Trump's inauguration in January.

It could be that the peso is rallying simply because it fell too far and too fast. Or it could be that Trump's policies haven't proven to be as detrimental to the Mexican economy as feared. In any case, the point is that currencies across the board are climbing against the dollar, an unexpected development that investors should pay attention to.

Here are three ETFs that are poised to benefit if the dollar continues to slide:

 

WisdomTree Emerging Currency Fund (CEW)

The WisdomTree Emerging Currency Fund (CEW) provides exposure to an equal-weighted basket of 15 emerging market currencies and their money market rates. If the dollar decline goes on, emerging market currencies are likely to be some of the biggest beneficiaries.

CEW's basket includes the aforementioned Mexican peso, the Brazilian real, the Indian rupee and the Chinese yuan, among others.

CEW invests in forward contracts and doesn't pay regular dividends, but it has a chunky implied yield of 4.8%. Year-to-date, the fund is up 5.2% after returning 4.1% last year.

YTD Return For CEW, US Dollar Index

 

SPDR Gold Trust (GLD)

Widely regarded as a dollar hedge, gold has delivered on its promise this year. The SPDR Gold Trust (GLD) is up 9% year-to-date, and stands at its highest levels of the year just as the dollar drops to its lowest levels of the year.

That's no coincidence. The 120-day correlation between gold prices and the U.S. Dollar Index is about -0.62, the tightest level since 2012 (a correlation of +1 means the two always move in the same direction, while a correlation of -1 means the two always move in opposite directions).

If this correlation holds, GLD will continue to be one of the best anti-dollar ETFs available for investors.

YTD Return For GLD, US Dollar Index

 

VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC)

The VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC) is the second-largest emerging market bond ETF on the market, with $3 billion in assets under management, but it's often been overshadowed by the $9.8 billion iShares JP Morgan USD Emerging Markets Bond ETF (EMB).

If the dollar keeps dropping, that could change. The main difference between EMLC and EMB is that the latter invests in dollar-denominated emerging market bonds, while the former invests in local-currency emerging market bonds.

When the dollar is rising―as it's mostly done during the last few years―EMB will have superior returns to EMLC as depreciating emerging market currencies take a bite out of returns for the local-currency fund.

But if the dollar drops, the opposite will be the case. Appreciating emerging market currencies will add to the returns for EMLC. That's what's happened so far this year, with EMLC up 6.8%, compared to 4% for EMB. If the downturn in the greenback has more room to run, expect more outperformance for EMLC.

YTD Returns For EMB, EMLC

Contact Sumit Roy at sroy@etf.com

 

 

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