The U.S. dollar has resumed its long-term downtrend and is setting new record lows against traditional stores of values like gold and the Swiss Franc. In view of atrocious fundamentals and technicals, read “The U.S. Dollar Completes Bearish Head and Shoulders”, we believe that the U.S. dollar is poised to continue its slide over the months and years ahead.
The reason we care is that, while a weak dollar is friendly to equities in the short to mid-term, the value of our dollar denominated assets is being eroded by the ongoing currency devaluation. This article focuses on some of the steps we all should consider taking to protect our wealth.
Stocks are the main investments we recommend, and we’ll get to that portion of our portfolios shortly, but most of us have some of our capital in more liquid instruments which are the most vulnerable to dollar devaluation. The first action to take is to protect these liquid assets, starting with any cash we have sitting in low-yielding savings accounts or money market funds. Assets in dollar denominated bonds such as U.S. Treasuries are even more at risk, because they could suffer the double blow of currency devaluation and lower bond prices should interest rates start moving up from the current historically low levels.
There are many options to dollar proof your liquid assets and we’ll concentrate here on a few convenient ETFs (Exchange Traded Funds) frequently used for currency hedging:
- Dollar bearish funds. The main choice here is the PowerShares DB US Dollar Bearish Fund (NYSEARCA:UDN) which is designed to replicate the performance of being short the U.S. dollar against the following currencies: Euro, Japanese Yen, British Pound, Canadian dollar, Swedish Krona and Swiss Franc
- Hard currencies funds. While hard currencies are not what they used to be, there are a number of them which should continue to hold up well against the U.S. dollar, such as the Australian dollar (NYSEARCA:FXA), the Canadian dollar (NYSEARCA:FXC), the Brazilian Real (NYSEARCA:BZF) and the Swiss Franc (NYSEARCA:FXF)
- Precious metals funds. The primary choices are GLD and IAU for gold, PGM for platinum and SLV for silver
When it comes to the stock portion of our portfolios, the first rule is to only invest in market sectors with the growth potential to overcome currency valuation erosion, and for us here at the Green Investor it primarily means the selected green stocks which are most benefitting from the alternative energy megatrend.
Besides targeting industry sectors with superior growth, we have long been in favor of international diversification. The first reason is that we forecast that many foreign markets will continue to do better than their U.S. counterparts, emerging countries in particular. The second reason is that many of these countries also have strong currencies.
What few investors realize is that by investing in foreign stocks here in the U.S., with U.S. dollars, through an American Depository Receipt (ADR) or an ETF, your return is influenced by the return of the stock(s) AND any change in the exchange rate. The overall return of a foreign stock/ETF can be expressed by the formula (which intentionally omits the fund's expenses and a few other minor details):
Foreign stock/ETF Return = Return of foreign stock(s) X Return of foreign currency
We’ll use Brazil as a perfect present-day example to illustrate the performance impact of exchange rates. In the chart below we see that since the beginning of 2009 the Brazilian stock market advanced an impressive 80% as measured by the Bovespa index (blue line), but because the Brazilian Real (red line) also appreciated significantly against the U.S. dollar during the same period (about 35%), the actual return for the EWZ Brazil fund is close to 120%. As long as the U.S. dollar loses ground to the Brazilian Real, the Brazilian positions in our Green Portfolio will benefit accordingly.
Exchange rate contribution to foreign stock investments
click to enlarge
We do not have a crystal ball, but looking at all the evidence of increasing U.S. dollar weakness, we will continue our strategy of international diversification with a bias towards strong stock markets and strong currencies.
Disclosure: Long FXA, FXC, FXF, GLD, PGM, SLV