As the Czech Koruna Shows, Currency Allocation Makes Sense

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Includes: DBV, GCF, UDN, UUP
by: Roger Nusbaum

This chart depicts that the U.S. dollar has more than cut in half against the Czech koruna over the course of this decade. The Czech koruna? Really? Apparently so. The Czech Republic is one I keep tabs on because Jyske Bank covers it closely and writes about it a couple of times a week, and I read Jyske's commentary every day. The Czech Republic certainly has its issues. It is a deficit country, with the deficit getting larger; inflation has recently broken to the up side; they don't corner the global market in something the rest of the world needs; the stock market has participated in the global sell off dropping 18.5% from its high last fall; so there doesn't seem to be much in the way of standout information. Yet the koruna has more than doubled.

It has a trade surplus with the U.S. that has been growing. Maybe that is part of the equation? In 2007 GDP grew by over 6% so that might be it too. I certainly do not have all the answers, but I think this is more about strength in the Czech Republic than weakness in the U.S. One reason to draw this conclusion is that the koruna has gone up a lot against the euro during the same period it is up against the greenback. This might be consistent with something I have theorized about before, which is that there will be many countries that one way or another become more important in the world economic order. This could mean a country goes from completely irrelevant up to merely unimportant, but it is still becoming more important. The point is not that anyone should go out and buy korunas, but in thinking of cash as an asset class, and trying to look ahead to where returns might need to come from, we need to understand this sort of thing.

On this second chart, we see the koruna going up more than SPY. Sometimes the two correlate kind of closely, but the koruna has been immune to declines when stocks sell off.

Before the decline that started in October, the equity returns charted were just fine, and the currency was right there with SPY.

That is obviously looking back. Looking forward I wouldn't think foreign currencies could go up that much from here versus the dollar (insert nervous smile). But what if some currencies average 6-8% over the next couple of years and domestic equities do the same?

Currency is usually less volatile than equities. If the two return the same, wouldn't choosing the product with less volatility make more sense? Unfortunately there is no way to know if equities will return less than normal, but there is some visibility for it. In that context, allocating some small portion to currency makes sense. Maybe that should be via some sort of managed vehicle like a fund or a manager or on your own, but as an asset class it has been, and I believe will be, compelling. It will also become easier to access currencies.

These types of posts always draw comments about currencies not being appropriate for most people. Well maybe, except there are fewer moving parts to most currencies than most stocks. Also just because something may not be ideal does not mean that it should not be studied and possibly utilized in moderation. Do you think anyone out there ever started out with mutual funds and then as they learned more began to integrate individual stocks?

Don't misread this as 'currencies are easy'. They are not, not by a long shot, but that still does not mean they should be avoided either.