Your Playbook To Profit From Falling Currencies

Includes: EEM, EWA, THD
by: StreetAuthority

By David Sterman

In recent days, investors might not have noticed a very unusual trend playing out in global markets. A number of once-robust currencies are in free fall against the U.S. dollar -- and counterintuitively, that spells opportunity for U.S. investors.

Looking For A Bottom
From the South African rand and the Brazilian real to the Australian dollar, a worldwide slump is emerging. It's very unusual for currencies to gain or lose value in a rapid fashion, but the recent charts are quite humbling, as this chart of the Australian dollar shows.

For U.S. investors with exposure to these markets, the currency shift eats away at a stock or fund's value, which comes on top of existing weakness in many foreign markets when denominated in their own currencies. For example, the iShares MSCI Australia Index Fund ETF (NYSE: EWA) has underperformed the S&P 500 by a stunning 20 percentage points since the start of May.

Australia's woes are due to perceptions of a slowing economy in China, which has recently had a voracious appetite for Australian commodities. It's no coincidence that the South African and Brazilian economies, which also have a heavy dependence on commodity exports to China, are also slumping right now.

The China contagion appears to be spreading to countries that aren't focused on commodities. The iShares MSCI Thailand Capped Investable market index ETF (NYSE: THD), for example, has dropped from $95 to $79 in just one month, with some of that weakness attributable to currency effects as the Thai baht slides. (Investors who suffered through the Asian currency crisis of 1998 probably don't want to hear about the baht, which utterly collapsed 15 years ago.)

Is it time to prepare for another global meltdown as we saw in 1998 and again in 2008? No way. In fact, this is the time to focus on the opportunities that are emerging for these markets.

I've written a number of times that emerging markets have far more robust long-term growth prospects than developed markets, and equally important, these economies are so much more effectively managed (with much deeper currency reserves) than they were a few decades ago.

In a recent article, I also noted that they were comparatively inexpensive right now. In just the past month, the iShares MSCI Emerging Index ETF (NYSE: EEM) has underperformed the S&P 500 by 10 percentage points. Over the past two years, that performance gap widens to a stunning 43 percentage points. In that time, the U.S. dollar has strengthened roughly 10% against a basket of global currencies, which partially explains that gap.

But here's the rub when it comes to currency impacts and global investing. A series of short-term factors can push the dollar up (and other currencies down), but that can actually provide relief to countries on the other end of the currency trade.

Consider Brazil and Australia. Those countries had been suffering from an overly robust currency in recent years, which made their (non-commodity) exports uncompetitive and introduced inflationary pressures from rising import prices. However, that serious headwind is vanishing quickly.

Since the summer of 2011, the Brazilian real has weakened from 1.60 to the dollar to a recent 2.13. That 33% depreciation is being largely cheered in Sao Paolo and Rio de Janeiro, even if it is being mostly ignored here.

These currencies can still fall further in the near term, but long-term trade flows suggest they are already becoming quite undervalued. And over time, as China and other key currency factors start to loosen up, these flagging currencies are likely to rebound. That will inflate your returns if you own stocks or funds that are invested in these economies.

The falling currencies have been a headwind in recent quarters, but you should now be looking at them as a potential tailwind.

Risks to Consider: The real risk here is the Chinese economy, which appears to be slowing. If this huge economy -- the world's second largest -- really stumbles, then emerging markets, along with their currencies, will slip yet further.

Global investing is surely not for the faint of heart, as these rapid currency swings are showing. Yet it's crucial that you stay focused on the still-impressive long-term trajectory for many of these economies. On a relative basis, they haven't sported this much value in several years, which for far-sighted investors should spell opportunity. Be prepared for more near-term choppiness, which is the price to pay for exposure to long-term upside.

Original Post

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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