The first half of 2011 has been a rollercoaster ride for currency markets as investors digest news from the U.S and abroad regarding budgets and possible defaults.
The big news in the U.S. has to do with the current debt ceiling and whether the government will raise the current level or begin a move to austerity. And, across the Atlantic, concerns about debt defaults that began in Greece have now spread to Ireland, Spain and most recently, Italy.
Worries about Europe’s economic health has put downward pressure on the euro and boosted the dollar. However, on days when the bigger concern is the U.S. deficit, it’s the dollar that falls and the euro that rises.
While you can play ETFs like the Rydex CurrencyShares Euro Trust ETF (NYSEArca:FXE - News) to get a piece of the dollar-euro cross, I’m here to tell you there are plenty of other currency ETFs that can help diversify a portfolio that have nothing to do with this trans-Atlantic dynamic.
So, let’s take a look at FXE and some of the other ETFs that allow you to play currencies ranging from the Swiss franc, to the Japanese yen, to the New Zealand dollar, to those from the emerging markets.
Euro And Dollar
The recent focus on eurozone and possible default issues with several countries has put extreme pressure on FXE following a pretty good run.
It reached an 18-month high in May before the news regarding Greece and other eurozone countries began to worsen. This week, FXE is trading near a four-month low as Italy joins the conversation of nations in trouble.
That said, I still think the deeper trend for the US Dollar Index and UUP remains bearish. This theory is based on the long-term trend of the US Dollar Index and the fact the U.S. government is OK with a weak currency because it makes U.S. exports cheaper.
Last year, President Obama stated his intentions to double exports in the next five years, and the only possible way to achieve this goal is with a weak currency.
Another factor would be the possibility of a third round of so-called quantitative easing, which would put more pressure on the greenback.
In that context, I believe UUP’s recent bounce has to do with the fact the news out of Europe is worse than what’s coming out of the U.S. as Congress grapples with how to raise the debt ceiling while laying the groundwork for a healthier longer-term fiscal situation.
In other words, the dollar just happens to be the best of the worst at the moment.
So, if concerns about Italy subside, the euro is likely to spike and UUP will resume what I consider to be its secular downtrend. On the other hand, if Italy requires a bailout, the exact opposite could occur.
Yen And Swiss Franc:Safety Plays
As investors fret over whether the euro is worse off than the dollar, two other currencies loom largely as safe havens in volatile times.
The Rydex Currency Shares Swiss Franc Trust (NYSEArca:FXF - News) has risen 13.8 percent year-to-date, and hit an all-time high in July. The ETF’s performance reflects—as it has for years—a currency backed by low inflation, a good economy and few national debt issues.
The Rydex Currency Shares Japanese Yen Trust (NYSEArca:FXY - News) is another ETF worth looking into. It’s up only 2.5 percent this year, but has historically outperformed when equity markets struggle.
The yen has had a strange year, as it hit an all-time high in March after the Japanese earthquake and tsunami, only to fall to a multimonth low in April.
The currency has since begun grinding higher, and is now about 2 percent shy from a new high.
What makes the two currency ETFs attractive is that regardless of where the problems arise−the U.S. or eurozone−the search for safe havens will likely continue into the end of the year and beyond.
I have owned FXY on behalf of several clients for a couple of years and will continue to hold it as my bear market hedge.
The Other Currencies
CEW attempts to create a return that reflects other money market rates in selected countries as well as changes of the currencies relative to the dollar. The ETF is up 2.8 percent in 2011 and has an annual distribution yield of 3.6 percent.
Its regional breakdown is 42 percent in Asia; 33 percent in the Middle East and Africa; and 25 percent in Latin America. CEW has an annual expense ratio of 0.55 percent, which is relatively affordable, considering the niche exposure the ETF provides.
This ETF quietly broke out to a new 52-week high last week on heavy volume. The underlying currency, referred to as the “kiwi,” traded at the highest level against the dollar since 1981.
Its performance reflects the fact that New Zealand, like Australia, is benefiting from the Chinese demand for commodities. Its currency and its entire economy are along for the ride. The biggest risk to the kiwi would be a slowdown in the Chinese economy, and so far that hasn’t really materialized.
If you don’t think the eurozone will have to bail out any new nations, and you believe the U.S. will figure out its debt issues in the near future, you have a different view on the world of currencies than I do.
But, any way you look at it, adding currency ETFs to your portfolio provides diversification to the equities, bonds and commodities you probably already own.
A great example of how diversification works is considering that FXY, the CurrencyShares yen ETF, rose 22.5 percent rise in 2008 when the S&P 500 fell by 38.5 percent. When stocks rebounded in 2009 with a rally, FXY only lost 3 percent.
That’s a lot of upside, for a little downside risk, and that’s one of the reasons I believe there’s room for currency ETFs in most investors’ portfolios.
Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.