Which Currency ETF is the Best Hedge Against the Dollar?

Roger Nusbaum submits: There is a post down below by Alligator Investor that I'm not sure is correct, conceptually. The post looks at the volume of all of the Rydex Currency Shares ETF.

The euro ETF clearly has the most volume by a mile but I'm not sure I can agree with AI's conclusion that "FXE is clearly the best choice for a low cost, exchange-traded hedge against a weakening dollar."

FXE has been the volume leader of the bunch ever since the others were listed in last summer but, to use an analogy, Microsoft is not a better proxy for tech solely by the virtue of having more volume than Qlogic (QLGC).

Those two tech stocks are totally unrelated. The fundamental goings on with the seven different countries behind the currency ETFs may or may not be totally unrelated. Making a decision between several investments based on volume alone doesn't seem to make sense to me.

The chart below captures all of the single currency ETFs. Three other currencies have outperformed the Euro: the Mexican peso, the Aussie dollar and the British pound. The argument seems to be based on volume, which of course looks back but the volume leader has not been the price leader -- not even close. Looking forward the Euro may or may not be the top performer, but volume in the ETF will not determine which currency does lead.

Disclosure: FXA and FXS are client and personal holdings.

Comments

[David Jackson:]

The original article argued that ideally you want a basket of currencies if you're betting against the dollar, not a single currency. But the problem is that DBV isn't a good hedge against the dollar for reasons he outlines. The advantage of the Euro is that it represents the largest currency block outside the US, so in some ways is "diversified". Problem with the single currency ETFs is that you're not only betting against the dollar, but you're betting for another single currency -- which isn't the goal of the trade you're trying to do.

2006 Nov 01 09:13 AM

[CrossProfit:]

Alligator Investor said:
“At this time, only FXE and DBV have enough trading volume to be really liquid. FXF could be traded with careful use of limit orders. The rest are languishing.”
Alligator Investor referred to volume from a liquidity risk concept, not that volume dictates higher returns.

Roger Nussbaum said:
“The argument seems to be based on volume, which of course looks back but the volume leader has not been the price leader -- not even close.”
The chart posted by Alligator Investor shows that it’s not even close. The author is talking about the volume/liquidity column.

The question I would raise; is the liquidity concept in ETF’s the same as stocks or is an ETF more similar to mutual funds in this respect?

David,
Didn’t see the original article, but if what you say is the case, then SA editors over edited this one. AI’s assumption that the Euro is more diversified than Cable, for instance, simply because the Euro represents several countries is questionable. All currencies are heavily influenced by the decisions of the corresponding central bank. The last time we checked, the ECB was calling the shots for the euro and not a diversified number of central banks.

Perhaps we should say that the Dollar is diversified because it represents 50 different countries! Heck, there is less economic correlation between Alaska and Nebraska than between Belgium and Italy. Don’t forget the satellite ‘dollarized’ countries like Panama, Ecuador etc.

Perhaps SA can post the original unedited AI article so that we can get a handle on this one. Maybe Roger read the original too!

Disclosure: Comment submitted by a CrossProfit analyst and may not reflect the opinion of CrossProfit.com.
www.crossprofit.com

2006 Nov 01 11:04 AM

[Roger Nusbaum:]

Volume is not much a driver for determining liquidity. The nature of the product is that specialsts can create shares if needed and there is generally a willingness to gt trades done. According to Bloomberg, via a call to Schwab, 100% of the volume today in FXF the Swissi ETF has been in between the bid and the ask. This says to me that liquidy is just fine even if it is not apparent in the number of shares traded.

Trades in the middle is something I have commented on before. Use reasonable limits nad have a little patience.

2006 Nov 01 01:50 PM

[CrossProfit:]

Correct when buying. Incorrect when selling. Less than 10,000 shares traded per day may have a liquidity problem on a severe downturn. This may be tested in the near future. The same applies to lightly traded stocks. Not a problem when buying, just try to sell into a zero volume day.

2007 May 04 12:52 PM