{"id":37773,"date":"2013-04-23T13:54:31","date_gmt":"2013-04-23T17:54:31","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=37773"},"modified":"2013-04-23T13:54:31","modified_gmt":"2013-04-23T17:54:31","slug":"currencies-for-the-stock-investor","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/04\/23\/currencies-for-the-stock-investor\/","title":{"rendered":"Currencies for the Stock Investor"},"content":{"rendered":"

By The Sizemore Letter<\/u><\/a> <\/p>\n

If you\u2019ve ever wanted to lose your hair, develop a stomach ulcer and put yourself at risk of an early heart attack, I have a recommendation for you: trade currencies!<\/p>\n

I say this (mostly) in jest, but currencies are an area that a lot of investors find baffling.\u00a0 With stock market investments, you have something at least semi-tangible to analyze.\u00a0 You\u2019re looking at companies with assets and, hopefully, streams of income coming down the pipeline.\u00a0 If you are a value investor, it simply becomes a game of paying a reasonable price for those assets and the income you expect them to generate.\u00a0 And I could make very similar comments for bond interest, real estate rental income, and any number of other investments.<\/p>\n

But currencies?\u00a0 How do you determine what a \u201creasonable\u201d price for a currency is?\u00a0 You can get academic, and use some variation of a purchasing power parity<\/a> model.\u00a0 Or, you could a rule-of-thumb approach like the Big Mac Index<\/a>, developed by The Economist<\/i>, which ranks currencies based on the price of a McDonalds Big Mac translated into dollars at current exchange rates.<\/p>\n

You could<\/i>, of course.\u00a0 But there is a big problem with using a model like these: they don\u2019t work,<\/i><\/b> or at least not on any reasonable timeframe.<\/p>\n

In fact, currency moves are often completely contrary to what we learned in business school.\u00a0 The principal of interest rate parity<\/a> tells us that it is impossible to consistently profit from the \u201ccarry trade,\u201d or selling low yielding currencies and using the proceeds to buy high-yielding currencies.<\/p>\n

Whatever you gain in extra yield you lose in currency depreciation.\u00a0 Or so the theory goes.\u00a0 But in practice, the complete opposite is true. <\/b><\/p>\n

\"DBV\"<\/a><\/p>\n

Take a look at the stock chart for the PowerShares DB G10 Currency Harvest ETF (NYSE:$<\/span>DBV<\/a>).<\/b>\u00a0 This ETF generates market-like returns by shorting the three lowest-yielding currencies of major industrialized countries and investing the proceeds in the three highest-yielding.\u00a0 The strategy has delivered nearly 60% returns since 2009.<\/p>\n

This carry-trade strategy doesn\u2019t always work; when the market goes into panic mode and leveraged investors rush to close out their trades, years of gains can be wiped out within days.\u00a0 But it shouldn\u2019t work at all.\u00a0 And yet it does\u2026<\/p>\n

Investors can experiment with strategies like these with whatever portion of their portfolio they dedicate to alternative investments.\u00a0 The same is true of managed futures strategies, though this needs a little explanation.\u00a0 There are plenty of professional and amateurs out there that generate decent and consistent returns trading currencies, and their returns are often times uncorrelated to the stock market.<\/p>\n

But this is a particular skill that I have never seen anyone learn from a book, an article, or from a shrink-wrapped kit sold on a late-night infomercial.\u00a0 From what I can see, some traders have something of an intuition here.\u00a0 I don\u2019t have it.\u00a0 And chances are good that you don\u2019t either.\u00a0 There is nothing wrong with allocating a small portion of your alternatives portfolio to an active currency trading strategy.\u00a0 But be honest with yourself about your trading abilities.\u00a0 And if you use a manager, make sure you are comfortable with his or her track record.<\/p>\n

What about more conservative investors?\u00a0 Can currencies play a role in their portfolios as well?<\/p>\n

Absolutely.\u00a0 I only makes sense to diversify your cash savings among several world currencies if your bank or broker will allow you to.\u00a0 The same is true of foreign currency bonds.\u00a0 But remember, unless you have extensive business or personal commitments abroad, it makes sense to keep the bulk of your savings in the same currency as your living expenses.\u00a0 Doing otherwise isn\u2019t investing; it\u2019s gambling.<\/p>\n

Getting back to the stock market, currencies get very complicated very fast.\u00a0 I regularly recommend and buy shares of foreign-domiciled companies.\u00a0 In fact, my entry in the 2013 InvestorPlace Best Stocks<\/a><\/strong> contest was German automaker Daimler AG ($<\/span>DDAIF<\/a>),<\/b> the maker of the Mercedes Benz.<\/p>\n

A drop in the euro would be bad for American investors in Daimler because its stock price would be translated at a lower exchange rate, right?<\/p>\n

Well\u2026sort of.\u00a0 But Daimler sells roughly two thirds of its cars outside of the Eurozone\u2026so a falling euro means that foreign revenues translate into euros are worth more\u2026though it also means production costs from overseas dig deeper into margins\u2026unless the company treasury is hedging its currency exposure\u2026<\/p>\n

You can think yourself into a circle when you ponder currency effects too long.\u00a0 Currencies do matter, particularly in the case of emerging markets, but in most cases business fundamentals matter far more.\u00a0 Barring a currency collapse\u2014which I believe may be a real possibility in Japan<\/a> in the near future\u2014you don\u2019t need to spend an inordinate amount of time researching them.<\/p>\n

Sizemore Capital is long DDAIF<\/em><\/p>\n

SUBSCRIBE\u00a0<\/a><\/strong>to\u00a0Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

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