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"The market can remain irrational longer than you can remain solvent" - John Maynard Keynes
Saturday, January 03, 2009
Shorting the US dollar
I received a couple of questions that I thought a broader audience may be interested in reading. The first question regards the US dollar and the second on gold. I'll post the gold answer later.
What is the best way to short the US dollar
There are probably five primary ways to do this.
1. Through forex ETFs or mutual funds. I think http://www.merkfund.com/ has some that might be interesting. I think one of his funds does currencies and gold. All of these are implicitly short USD and long something else
2. Currency futures. Your risk reward is the same as a regular forex transaction except instead of daily interest you receive interest in a zero coupon fashion through the price paid. A forex position has no expiry whereas a futures position does.
3. Currency future option. This has a well defined risk, never more than the option price paid. The upside is the same as the currency futures position. This loses value over time as do all options.
4. Forex position. This is effectively borrowing in one currency to buy another. This is really no different to taking a 100k loan from your bank, converting it into another currency and then depositing it in that currency. In fact, that is the mechanism that is used. This can be achieved with an extremely low margin value (2%). Therefore the upside can be substantial compared to your margin but you can also easily get wiped out unless you fully fund the transaction (i.e. don't use margin). You earn interest in the long currency and pay interest in the short currency. If you make money on the spread then it's is said to have negative cost of carry and conversely there is a cost of carry.
5. Investing in productive assets in foreign countries. This is simply investing in foreign countries. If you are US based then it might be investing in Europe, Australia, China etc. If you can find undervalued assets in these countries then you get the double whammy of currency appreciation and price appreciation. You also receive dividends in the foreign currency which over time should grow. This is ultimately what Buffett ended up recommending after taking type 2 or 4 positions previously. He realized that the cost of carry created a situation whereby he needed movements to occur in a certain time frame.
You need to be careful that the company you are investing in overseas doesn't cancel out your forex position. A retail business would have expenses in foreign currency (buying products from china) and in local currency (staff) and all profit would be made in local currency. A service business would likely have both profit and loss in local currency. A gold mine would have profit in foriegn currency (based on the USD gold price) and costs largely in foreign currency (USD price of tractors, diesel etc).
As I am investing with Australian dollars and I expect the AUD to appreciate against most currencies then I am forced to primarily invest in Australia. As I expect to lose money on any foreign positions based on Forex movements. I have somewhat hedged this with out of the money currency futures options but they have a cost which is unfortunate. If I earned or invested based on USD today then I'd be almost entirely invested outside the country.
As a value investor the most business like approach here is to invest in productive assets overseas. Have those assets grow and create earnings in foreign currencies over time. The problem with all the alternatives is the ongoing costs and the requirement to not only be right but to be right in a specific amount of time.
If you were determined to make a speculative bet on currencies I'd recommend options. Just make sure that you have sufficient funds to roll positions over for a few years and the discipline to actually do that. I've bought quite out of the money AUDUSD options at below 1% of face value because I believe when the currency moves occur they'll be quite significant and because I don't want to use much capital in case it takes a long time.
Disclaimer and Disclosure
Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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