Investors, Traders Create 'Perfect Storm' for Currency ETFs

By Murray Coleman

As Federal Reserve Chairman Ben Bernanke signals that short-term interest rates are going down in the U.S., activity in exchange-traded funds linked to different currencies around the world is spiking.

And that's bringing both short-term speculators as well as long-term ETF investors into the market. The combination of more economists forecasting a prolonged weakening in the greenback and record-high price gains are providing both fundamental and technical analysts with a field day.

The result is something akin to a perfect storm in drawing attention to a rather new form of ETF investing, says Joe Baker, a longtime advisor at Alcus Financial Group in Mt. Pleasant, S.C.

"I've never seen this much interest in currency ETFs before," he said with a laugh. "There's just a pile of money coming into these funds now."

Take the Rydex CurrencyShares Euro Trust (NYSE: FXE). [Editor's note: All charts cover recent two-year trading preiod.] In the past 12 months, FXE's price has jumped 14.5%. Along with that rise, its average daily volume has risen from around 100,000 shares in early September 2007 to more than 400,000 shares now.

"We've got the Fed chairman this week essentially telegraphing to the market that rates are coming down," said Jerry Slusiewicz, president of Pacific Financial Planners in Newport Beach, Calif. "That's driving up prices and sending trading volume up in droves."

He hasn't jumped on the bandwagon yet. Still, Slusiewicz says FXE looks very attractive right now on several different levels. And as midday approached on Thursday, he was inching closer to making a call for some of his clients.

On the technical side, FXE broke what's called a triple-top on price charts. That's a rare occurrence. But since the current run began with the euro in early fall 2007, Slusiewicz says FXE's low point has been about 5.5% of its current high.

"So even if there's a fallback, the short-term downside risk in this current pattern seems pretty attractive at less than 6%," he added.

Slusiewicz uses stop/loss orders with any ETF transactions. For FXE, he's looking at $143.40 per share. "That's the low side of the trading range we've been in since late October of 2007," he said.

Slusiewicz also checks fundamentals before buying an ETF. Those are attractive as well for FXE, he says. With comments made by Bernanke before Congress on Wednesday and Thursday, futures traders are now pricing into the market a 50 basis points rate cut, Slusiewicz says.

That makes the U.S. dollar less attractive globally. "So far, the European Union hasn't cut rates, even though they've talked about it," Slusiewicz said.

Another confirming signal could be that gold keeps soaring since the Fed started cutting short-term rates in September. Slusiewicz also owns StreetTracks Gold Shares (NYSE: GLD). That ETF's price has shot up 45% since early fall.

"So gold traders are expecting the dollar's weakness to continue," said Slusiewicz. "We're seeing a lot of confirming signals coming together right now. And it looks like this could be a long-term trend."

Bruce Zaro, a strategist at Delta Global Advisors Inc., says he's seeing a lot of interest in currency ETFs lately from traders and long-term oriented investors.

"From a technical standpoint, this looks like a good buy for traders," he said. "And given that FXE's dividend yield is around 2.74% right now, which is on par with the broad stock market, that's another real plus."

With Tuesday's breakout, his technical analysis of price charts indicates that FXE could move up to the $160-per-share range later this year. "If that happens, its price appreciation as well as its yield would translate into a gain of 9.33% since Tuesday's breakout," Zaro added.

But currency ETFs are also attractive to long-term investors, he says. "We consider currencies as a separate asset class from stocks and bonds," said Zaro. "They're categorized in our portfolios as true alternative investments."

Currency ETFs as a whole make up about 5% of the firm's long-term-oriented portfolios. Some more aggressive traders prefer to use up to 10% of their total assets in various currency ETFs.

Besides FXE, Zaro also is investing in CurrencyShares Australian Dollar Trust (NYSE: FXA) and CurrencyShares Swiss Franc Trust (NYSE: FXF). Both also have been on a run lately.

"Fundamentally, you can also make a strong argument that the Aussie dollar with its base in natural resources is likely to keep experiencing strong growth," Zaro said. "We also think that the Swiss economy is a fairly stable economy and has sound money policies that should hold up well in the future."

Roger Nusbaum has been investing in currency ETFs since their debut some two years ago. The portfolio manager at Your Source Financial in Phoenix, Ariz., is cutting back in the firm's stake in FXE, though.

He bought FXE last fall at around $141 per share. Nusbaum sold it this week at $149.66 on the current spike. "Similar to oil and other currencies, typically when you see a big move like this, you see speculators coming out of the woodwork," he said.

Nusbaum says over the next few months, FXE could have already peaked. "But we didn't completely give up on the theme of a weaker dollar," he added. "It was more of a trimming."

As the spotlight shines brighter on the euro, he's holding on to two-year notes bought directly in some less-known foreign markets. Those include short-term paper from Norway, Australia and the U.K.

"We're lightening up a little on the euro," Nusbaum said. "The big picture, though, is that the dollar will probably continue to show weakness. But in the short run, it's plausible that the U.S. dollar will have a snap-back rally."

Investors without exposure to currencies need to balance current conditions with longer-term objectives, he says. "Trading on short-term movements in currency is not something I'd suggest," Nusbaum said. "We've been in them for a relatively long time now. I'm just trying to protect those profits."

But for someone with no exposure to currencies and considering adding this asset class to their long-term asset allocation plan, he advises taking a slow-but-steady approach. "At this point in the run-up in foreign currencies, it might be better to wade into the market now," Nusbaum said. "If your allocation calls for 5% in currencies, perhaps start by investing 2% of that now."

He tells financial advisors working for the firm that currency ETFs should be viewed as a different sort of investment than stocks or most fixed-income funds.

"If you're going very short in bonds, there's probably not a lot of difference between owning bonds and currency ETFs," Nusbaum said. "But if you're buying something because it looks like interest rates are going up, then currency ETFs provide you with more of a chance to directly benefit from that movement."

Comments

[just.a.guy]

It is also worth looking at the Rydex Yen fund (FXY, in the same family), as a bet on continued printing press hyperacceleration by the US Fed, and the potential unwind of the Yen carry trade -- maybe even the development of a carry trade in ever-cheaper US currency.

[A.S.D.]

Be careful here...exact repeat of the last time inflation scare/weak dollar theme was propped up-end of January. That one lasted a few days for FXF which I just cashed out of. The problem is most people who are into these ETFs are probably heavy on commodities too and most likely are shorting US and or emerging markets as well. It all works until it doesn't.

[jr7107]

Japan is an export economy. Rates are 0.5%. JPY export goods will become more expensive (autos, plasmas, LCDs). The BoJ intervenes to support the exporters and reduces rates. The FXY is political. How does the carry trade unwind? What low rate currency does it go to? Why does the non-resource based JPY stand up?

[bhakta]

I was not aware of the FXA and others. This is interesting. Thanks for the posting.

[300mph]

This article is late to the party.

[whidbey]

The hedges play in currencies to offset emerging market bets (think China), so we must beware the 800 pound ape, when he panics there is blood everywhere in the market. Possible alternative long range plays based on the US inflation is SLV (any producer), junior golds, and natural gas (like UNG). Currencies will do, but anywhere governments are involved there is danger of manipulation to be discounted.

[Brian inMontreal]

This is not investment advice but don't forget to watch the currency of your neighbors Canada (FXC) and Mexico,
300mph has a point, but to say 1.60 is possible like gold at $1000 or even $1100 certainly has to be a consideration with the weakness we are now seeing in the USD. I'm hoping any reversal should be slower and easy to see in currency than gold or gold stocks which may change direction alot faster. If you want faster, check the article on this site about the New (powershare like) commodity doubler ETFs coming out.

[My Two Cents]

1) Swiss franc has been gaining against Euro, and it may also be relevant that one of the major Swiss banks predicts that Swiss equity mkts will do better than Europe over the next months. 2) Currencies have long cycles and tend to overcorrect. Not inconceivable that USD becomes oversold and has a (brief?) upward respite.

[mkreisel]

Currency shares are not the safest investments. If the underlying trustee goes bust, so goes away your money. People should their prospectus more carefully.