How Will a Stronger Yen Affect Japan ETFs?

How will a stronger yen affect Japanese exchange-traded funds such as iShares MSCI Japan (EWJ)?

In my recent Forbes column on Japan, I mention that the yen is perhaps the world's most undervalued currency. It is even cheaper than the Chinese yuan by some measures.

Two weeks ago, the Japanese currency hit an all-time low against the euro (down 15% in the last year) and its real trade-weighted value fell to its lowest since at least 1970, according to an index tracked by JPMorgan.

But Japan’s currency has already gained almost 3 per cent this week, the biggest increase since late 2005, and was at 117.66 against the dollar in late trading in Tokyo on Friday. On Thursday, the yen reached 116.97 against the dollar, the highest since December 13, after rebounding from a four-year low of 122.19 at the end of January this year.

This stronger yen has led to weaker equity markets because it hurts large Japanese exporters and exports have been the key impetus behind Japan's stronger economic growth. A stronger yen also means that the foreign revenue from companies like Toyota will appear in financial reports as weaker when say dollar numbers are translated into yen for reporting purposes. But for Japan ETF investors, a stronger yen will somewhat offset these negatives since the ETFs are unhedged meaning a stronger yen will help returns.

Investors looking for a more direct play on the yen can look at the new Rydex Japanese Yen ETF (FXY) which was up 0.6% Friday.