Currency Bundles Pegged to the Dollar

 Good news for currency investors looking for bundles of currencies other than the Group of 10!  Last Wednesday, June 18, Barclays Bank finally brought to market two bundled ETNs that have been in the works over a year.  And, each of the currencies in both bundles are pegged, to some degree, to the dollar.

Further good news, WisdomTree began trading two new currency ETFs on June 25^th: the New Zealand Dollar Fund (BNZ), and the South African Rand Fund (SZR).  Both funds are off to a positive start, beginning their life at $25 per share.  BNZ was up $0.18 and SZR was up $0.36 after a couple of hours of trading.

The Barclays bundles are more complex.  The first is the Asian and Gulf Currency Revaluation ETN (PGD).  This ETN includes currencies of the Saudi Arabian riyal, Hong Kong dollar, United Arab Emirates dirham, Singaporean dollar and Chinese yuan.  All these currencies are welcome additions to our list of investing options.  They are all, also, pegged to the U.S. dollar, at least according to Barclays.  This is certainly true of the Saudi riyal. 

Saudi Arabia riyal/ U.S. Dollar, YTD

For YTD, note the effectiveness of the Saudi peg!  Generally currencies that are allowed to trade will show some variation around the pegged price.  So, the absolute fixity of the riyal tells me that the Saudi monetary authorities are to sole sellers of their currency.  I know of no other way to keep this kind of fixed price.

I showed the variation of the Hong Kong dollar a few days ago.  I haven’t found a source to quote the EAE dirham, but I can show Singapore’s dollar and the Chinese yuan.

Singapore dollar/U.S. Dollar, YTD

This does not look like much of a peg, to me.  SGD is up 6.5% for the year.

The yuan is a similar story:  up 5.8% ytd.

Chinese yuan/U.S. Dollar, YTD

It is not secret that the Chinese are allowing the yuan to gradually revalue.  They allow a moving band to exist around the dollar, with the band gradually drifting upwards over the year.

The rationale for this bundle is that all the currencies, pegged to the dollar as they are, are strong candidates for revaluation.  In other words, they are all value plays in the currency market.  The case Barclays makes for them being undervalued is easily seen in the graph they provide in their SEC filing below. The graph below (click to enlarge) shows the current account balance of the GDP of each nation on the vertical axis and GDP growth percentage on the horizontal axis. 

This shows the U.S. is the sole country with a currency account deficit, a strong indicator of over-valuation of the dollar.  The second axis shows GDP growth percentage of the U.S. at less than 3%, while the rest of the currencies are over 5%, another indicator of imbalance.  Although the data shown are not proof that there will be revaluations, it does make a good case that there could be one.  On the other hand, the gulf nations recently reaffirmed their desire to keep the dollar peg, but that doesn’t mean they will.

Regardless of the revaluation event, however, a buy of this bundle is a carry trade positive.  There will be interest earned on the local currency deposits.  And, in a substantial deviation from the ETN method of handling interest earnings, the interest earned on this bundle will paid out quarterly by Barclays.  This feature makes both the new bundles more attractive, since the investor will not have to pay taxes on a phantom income.

The second ETN is the Global Emerging Markets Strategy ETN (JEM).  With fifteen currencies represented in the bundle, it is certainly the more diverse of the two.  They have three sub-bundles in the ETN:

1. Eastern Europe, Middle East and Africa is one bundle.  The specific countries in this region are: Hungry (forint), Poland (zloty), Russia (ruble), South Africa (rand), Turkey (lira). 
2. Latin America, which includes Argentina (peso), Brazil (real), Chile (peso), Columbia (peso), and Mexico (peso).
3. Asia, which includes India (rupee), Indonesia (rupiah), Philippine Islands (peso), South Korea (won), and Thailand (baht).

The graphic below (click to enlarge) represents what the index would have done had it existed prior to February, 2007, when it was first formulated.

JEM weights each currency equally in dollars, and will be rebalanced to this status in July of each year.

I like the diversity of this ETN, although the inclusion of Argentina in the Latin America portion of the index cause me shudders.  This country has an ugly history of mismanagement of its economy, currency and debt.  Fortunately it is only 1/15^th of the total index, but it is 1/15^th I would like to see gone.

Overall, I am glad to see the new offerings.  I hope there will be many other bundles of currencies offered in the future.  It give the investor a chance diversify his or her portfolio inexpensively and easily, a worthy goal for all investors who value a balanced approach to portfolio management.

Comments

[Desi:]

Hello,

First of all its a joy and pleasure to read your timely articles !

One question I have is on the latest signal from the Fed on holding the interest rates steady and probability of raising the rates in Q3/Q4 2008. The markets are already including this news in the currency valuation with dollar becoming stronger against Euro as well as the Yen. How would the strengthening dollar affect the two ETN's mentioned above and will the sky-rocketing inflation break the "Camels Back" in the emerging markets.

Thanks,

Desi

2008 Jun 26 08:16 AM

[Ray Hendon:]

Hi, Desi:

Thank you for your kind words.

Your questions are cogent reminders that nothing is permanent in the world of currency investing, and what's hot today may be decidedly cooler tomorrow. I wish I could give you a definitive answer to your questions, but I can't. I have only weak opinions on both questions. Remember, my opinions are free, and worth every penny!

A strong dollar would be a relief to all the gulf and asian countries in PGD, since they have been forced to follow the dollar down (for the most part) for about the last eight years. Higher dollar prices with respect to the Euro, e.g., would allow the Saudis to buy more European goods. But, it would diminish the chance of a revaluation and actually increase the odds of a devaluation for the weak currencies. But, I doubt that the dollar will make a dramatic turnaround. It is more likely that it will stop falling, and, perhaps, rise at a moderate rate. But, this guess can easily be wrong. So many things of a political and economic nature can occur that would turn everything in the opposite direction.

Your second question is equally difficult to be definitive with. But, the inflation we have experienced the last few years has been caused largely by increasing demand from the emerging markets. Their increasing incomes have pushed up their demand for food and energy, and their increasing industrial productivity has pushed up demand for metals and energy. In one sense, this type of inflation is greatly benefiting those emerging markets that sell food stufs, metals and energy--Brazil, Chile, Mexico, Russia, Australia,etc. So, this would actually benefit their economies, and, by implication their currencies.

Best wishes,

Ray

2008 Jun 26 10:02 AM

[phdinsuntan...:]

nice, but you are buying Barclay Capital risk firts and second, the promise of currencies appreciation. Just look the risk of this bank:

Europe March 31 2008 Capital/Assets
Europe
EU Broker UBS 1,9%
EU Bank Barclays 2,6%
EU Broker Commerzbank 2,6%
EU Bank BNP Paribas 3,5%
EU Broker Credit Suisse 4,4%
EU Bank Royal B Scotland 4,8%
EU Bank BBVA 5,6%
EU Bank HSBC 5,8%
EU Bank Santander 6,3%

SCARY Isn it?

2008 Jun 26 10:20 AM

[Desi:]

Ray,

Thanks for your prompt reply. I fully agree that there are so many factors that affect the currency markets. Hence every word of advice or hint is useful for an individual investor.

Thanks once again,

Desi

2008 Jun 26 10:32 PM

[deuxsous:]

Thanks very much for quickly reviewing PGD. One minor correction: the dividend payments are monthly, as with JEM, and not quarterly. Seeking Alpha's PGD chart shows an indicated annualized dividend of 5.5% but I couldn't verify that or where it came from. The Prospect is silent on anticipated dividends:

Seemingly PGD will offer both "creeping revalution" for $HK, $SG and CNY, but with the possiblility of an "overnight surprise" revaluation of the Saudi rial and UAE dirham.

I'm not a big fan of ETN's for their unclear US taxation, but if they pay a decent dividend they are OK for tax-deferred US accounts. there are some exposures it is hard to get in any other way than via ETN's.

I expect that JEM will be far riskier in any global economic slow down, but perhaps it will be less risky than emerging market equities or local bonds.

2008 Jun 28 05:43 PM

[Ray Hendon:]

deuxsous, Thanks for your 2 cents (:>). I agree that the three south Asian currencies are more likely to creep along with their revaluation--probably following China, for the most part. And, if Saudia Arabia makes a move, it will likely be a big one. But, I'm not sure I would bet on this outcome, especially if the dollar appreciates with respect to the Euro. EAE is more difficult to predict, but I doubt they will stray very fram from the Saudi camp.

I think you are right about JEM being the riskeir of the two funds. None of the JEM members are in a driving mode when it comes to the world economy, so they all are at the end of the whip, so to speak. China is more in control of its destiny, and in complete control of its currency, and any move they make will probably bring Singapore and Hong Kong with them. They have the reserves to do about anything the would like to do for now.

I hope you are right about the monthly dividends. This would make their offering more attractive to me and more competitive with ETFs.

Ray

2008 Jun 29 01:53 AM

[Brian Shriver:]

Ray:
Good stuff - thanks for the analysis.
I am wondering about the local currency interest rate that is available via these funds. For example, on the Wisdomtree website, they suggest that some currency ETFs will be implemented via non-deliverable currency forwards, which may not be trading at "full carry" and therefore may not reflect local interest rates. For example, the Chinese forwards imply a negative local interest rate.

I am wondering whether the local interest rates offered by these funds will reflect actual local rates or rates implied by forwards. Barclays can promise whatever they want but ultimately ought to hedge their exposure. What is your understanding?

Thanks and regards,
Brian Shriver

2008 Jun 29 11:35 AM

[Ray Hendon:]

Hi, Brain. Thanks for the comment.
The local currency interest rate is, as you have discovered, difficult to pin down. This is especially true when forward contracts are used as opposed to holding the currency and buying local short-term interest bearing instruments with it. I like the second approach--interest earnings are more predictible using this method.

With respect to China, as of now, the yuan cannot be held by foreigners and deposited in China, so there is no choice but to use the forward markets in other countries. Plus, even if you could hold the yuan directly, China severely restricts where foreign monies can be deposited. For Americans, and probably every other foreigner, they are held in exceptionally low interest-bearing accounts. This is an oddity (given their high inflation rate), but China is full of these kinds of restrictions and odd-ball policies. They are new to the internation financal system, and are warry of it.

So, the Chinese authorities keep a tight reign on their financial system (separate share classes, restricted bank accounts, etc.), and it will be a long time before they join the western world and allow more or less full access to all their financial instruments.

In the meantime, I stay out of their currency ownership. I am too uncomfortable with all their restriction and their poor prospects for the carry trade. If you want to take on the yuan as a value play, you could use the Singapore dollar as a proxy, but I don't know the interest rates forecast for this currency, and forecasting what Singapore will do in the future is beyond my abilities.

Best wishes,

Ray

2008 Jun 29 02:23 PM

[Ray Hendon:]

PS: It is, of course, possible to earn a negative roll when the interest rate where the money is borrowed is higher than that in the country in which the currency is purchased.

RH

2008 Jun 29 07:08 PM