Protect Yourself From the Volatile U.S. Dollar with Currency ETFs

By: Money_and_Markets

Ron Rowland writes: You’ve seen the headlines: U.S. Dollar Plunges! U.S. Dollar Surges!

Why should you care? More to the point, why won’t the dollar just hold still?

Actually, in one sense it does hold still. Whatever happens in the currency markets doesn’t change the number of dollars in your wallet — or your bank account. But it can certainly change what your dollars are worth in comparison to other currencies.

If you live in the U.S., the day-to-day swings in the dollar are nothing to worry about. The long-term downtrend in the dollar is another matter. Since the beginning of 2002, the U.S. Dollar Index has dropped more than 30 percent. That’s almost a third of your international purchasing power — gone!

Even worse, the Obama administration’s reckless spending — with the willing complicity of Bernanke’s Federal Reserve — threatens to send the dollar even lower in the coming years.

What can you do about it? Once again, ETFs come to the rescue!

ETFs Make Currency Trading Easy …

Investing in foreign currencies used to be difficult. Your choices were limited to trading risky futures, lining up at the currency exchange window at major airports, or bringing home some funny-looking bills and coins from your international vacation.

Now, thanks to ETFs, you can load up on euros, yen, pesos and pounds just as easily as you buy a stock. You can even go short in some of these currencies with inverse ETFs. So there’s no reason to keep all your eggs in the dollar basket any longer.

Of course, the fact that you can do something doesn’t mean you should do it. Always have a clear goal in mind before you trade any ETF, and make sure you understand the risks. And even if a trade makes sense for you, get started slowly.

For instance, suppose you just want to diversify your portfolio so you can have some protection from a falling dollar. If you don’t want to make a big bet on the dollar against any single currency, take a look at an ETF like the PowerShares DB U.S. Dollar Index Bearish Fund (UDN).

UDN gives you exposure to all the major world currencies.

UDN is designed to replicate a short position in an index that tracks the U.S. dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. In other words, UDN goes up as the U.S. dollar goes down against this basket of other major currencies.

Or you can take the opposite position with the PowerShares DB U.S. Dollar Index Bullish Fund (UUP). This one goes UP as the currencies mentioned above fall when measured against the greenback.

Maybe you have a strong feeling about the British pound. How can you turn your forecast into a profit opportunity? One simple way is buying CurrencyShares British Pound Sterling Trust (FXB), an ETF that holds a position in the United Kingdom’s currency.

Have a yen for the yen? CurrencyShares Japanese Yen (FXY) gives you a chance to profit when the yen is outpacing the dollar.

You can buy the British pound with FXB.

Lately, though, the opposite has been more often the case — the yen is one of only a few currencies weaker than the dollar in recent weeks. That ought to tell you something about Japan’s economy! So is there a way to profit if the yen drops?

You bet there is!

The ProShares UltraShort Yen (YCS) is a bearish yen fund. It’s also 2X leveraged so your gains are amplified if your bet is correct. For instance, if the yen drops 10 percent, this ETF’s shares stand to rise 20 percent. However, if you’re wrong, your losses can add up quickly. Therefore, timing your trades correctly is very critical.

I Want to Highlight One Other Currency ETF Because It’s So Unique …

The PowerShares DB G10 Currency Harvest Fund (DBV) tracks an index that shifts exposure based on the yield of the ten top world currencies — the G10.

With DBV, you’ll have the equivalent of a long position in the three highest-yielding G10 currencies and a short position in the three lowest-yielding G10 currencies.

If you know anything about hedge funds, you probably recognize this as the so-called “carry trade.” Put simply, it’s borrowing at low interest rates and using the loan to buy higher yielding assets elsewhere. It was an easy way to make big bucks for years. But those managers had their heads handed to them in 2008.

Now it’s beginning to look like the carry trade may start to work again. If it does, DBV is an easy way for you to get access to the same strategy millionaire hedge fund investors are using.

There you have it: Six ETFs to help you get in on the world’s currency markets. However, more than two dozen other currency ETFs and ETNs are now available. Unfortunately I don’t have room here to give you the whole list, but they aren’t hard to find. Look around and you’ll see many ways to get out of the greenback — or bet on its recovery.

Best wishes,

Ron

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