When it comes to the currency market there are two "big guys" that are often viewed as barometers. The U.S. dollar and the euro are the currency of the two most influential regions in the world today, and both have their issues that they must face in the future.
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.
The euro has more than enough well-documented problems, starting with Greece and moving onto countries like Spain, Italy and Ireland. There has been talk that the euro may not even be in existence in the years ahead, if the problems in the region are not resolved quickly. The CurrencyShares euro ETF (ARCA:FXE) is down 12% from its multi-year high set in May 2011.
During the same timeframe, the PowerShares DB U.S. Dollar Bullish ETF (ARCA:UUP) is up 6%, easily outpacing its european counterpart. With that being said, the ETF is down nearly 20% from its recent high set in October 2008. My outlook for the greenback is not positive, considering the amount of overtime the printing presses have been putting in. Eventually, the influx of new currency will push the U.S. dollar back to a new low.
In the last few years, both the U.S. dollar and the euro have been trending in the wrong direction. The trend, along with the reasons mentioned above, is why I am looking at emerging market currencies as alternatives. And there is one more very important factor. As the developed countries struggle with rising debt levels, the majority of emerging markets are better positioned with lower debt-to-GDP ratios. (For related reading, see An Inside Look At ETF Construction.)
The WisdomTree Dreyfus Currency Income ETF (ARCA:CEW) is composed of 12 foreign currencies that each account for about 8% of the allocation. The regional breakdown is: Asia (41%), Latin America (25%), and Europe, the Middle East and Africa (34%). The distribution yield on the ETF is 5% and the ETF is down 6% from the time the euro topped out last May.
The WisdomTree Dreyfus Commodity Currency ETF (ARCA:CCX) is composed of currencies from a basket of commodity-producing countries. Only half of the eight currencies are considered emerging markets, but it is an ETF worth mentioning. The four emerging markets (South Africa, Brazil, Chile and Russia) give investors an interesting mix of currencies. The embedded income yield is 3.8% and the ETF charges an expense ratio of 0.55%. The ETF is down 4.5% from last May.
A currency that has been in the headlines, and will likely stay there for the foreseeable future, is the Chinese Yuan. Most people believe the Chinese are holding down their currency versus the U.S. dollar and this has caused tension between the two countries. If the Chinese ever decide to let their currency float freely, it will likely result in higher prices for the Yuan. The Market Vectors Renminbi (ARCA:CNY) would be a way to play that scenario. The ETN does not move much due to the situation in China, and therefore is only up 1% since last May.
One of the other darling emerging market countries, Brazil, has seen its currency fall from its high, as the U.S. dollar has performed well since last year. The WisdomTree Dreyfus Brazil Real ETF (ARCA:BZF) is down 3.5% from May 2011, but in the last two months it has begun a major turn for the better. The outlook for Brazil's economy remains stable and better than many of its developed counterparts. The Real could be a less aggressive way to play the rise in Brazil.
The Bottom Line
If the european union falls apart, it will likely lead to a higher U.S. dollar that could hurt the emerging market currencies. There is also the potential of a global economic slowdown that would lead to the emerging market countries getting hit hard. As with every investment there is risk, however there is reward attached to the ideas above as well as diversification against a heavily weighted equity. (For more, see How To Pick The Best ETF.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.