Friday, October 1, 2010

Hedging Against (Further) U. S. Dollar Weakness: Part III

On September 8, I put up a post about ways to hedge against or profit from a decline in the U. S. dollar (the "dollar" herein, as opposed to dollars of other countries, also the "USD"). I listed three asset classes: gold, silver and certain foreign currencies. That post focused on gold and was followed up by a post on silver. This post discusses currency-related tactics I have been employing in personal investing.

An important impetus for the dollar weakness is that the Recovery Summer that the administration touted a few months ago has turned out to be unfelicitously named. The pace of economic growth has turned down, and even the Economic Cycle Research Institute has stated that there was a roughly 50-50 chance of another recession (the famed and so far unidentified "double dip") beginning soon.

This economic weakness has been associated with two dollar-weakening activities from the Fed. One involves the newly-introduced program in which the Fed has begun purchasing Treasury debt from the primary dealers that purchase the debt. This has been viewed in many circles as "monetizing the debt", a technique previously limited, in American eyes, to lesser countries.

A second involves the discussion by the Fed of the potential advent as soon as next month of another 2009-style "quantitative easing" program known colloquially as "QE2"; click HERE for a thorough though characteristically downbeat Zero Hedge discussion of this possibility. The mere discussion of this possibility (probability?) has already contributed to weakening the dollar.

A more fundamental reason to diversify from the dollar comes from the General Accounting Office of the United States, which reported on its latest audit of the federal government:

Three major impediments continued to prevent GAO from rendering an opinion on the federal government's consolidated financial statements . . .: (1) serious financial management problems at the Department of Defense, (2) federal entities' inability to adequately account for and reconcile intragovernmental activity and balances, and (3) an ineffective process for preparing the consolidated financial statements.

When a company's auditor cannot render an opinion on that company's financial statements, one has to worry about fraud and possible bankruptcy. So, exactly why is Federal debt trading at about 240 times "earnings" for a 2-year commitment of capital? Why not diversify into a higher-yielding vehicle from a country that has stronger audited results?

Since that September 8 post, the dollar has weakened a good deal for a short time period. A Bloomberg article summing up the trading week ending October 1 summarizes:

The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against six major counterparts, extended its biggest monthly drop since June 2009. The Dollar Index declined 5.4 percent in September, the biggest monthly decline since May 2009 when it fell 6.2 percent.

Nonetheless, the dollar is far from historic lows, and investors who wish to have non-dollar exposure on a time horizon extending beyond considerations of possible short-term "overbought" conditions may want to consider any of these positions, which I continue to hold as of the October 2.

My direct foreign-currency denominated exposure is to three countries: Norway, New Zealand and Brazil. Here is my reasoning and some detail on how to invest in each country's debt or currency.

I did research in non-mainstream U. S. raters of governments and found that while the U. S. federal government is not apparently near bankruptcy, it is also not a true AAA credit. In contrast, both Norway and the "twins" of Australia and New Zealand have garnered "true" AAA ratings both by a prominent Chinese rating agency and by some hard money authorities. Here is the Chinese agency's list of AAA-rated sovereigns:

Dagong rates Norway, Denmark, Switzerland, and Singapore at AAA, along with the commodity twins Australia and New Zealand.

Here is Eric Sprott's list (Mr. Sprott runs hard money investment vehicles):

. . . our model ascribed AAA ratings to the local currency debt of Australia, Canada, Finland, Sweden, New Zealand which matched the ratings given by S&P . . .

(Click HERE for a link to S&P's country rating list.)

Before going into the following details, interested readers may wish to look at charts of various currencies against the U. S. dollar. I routinely do this by going to and then putting in the currency pair symbols where a stock symbol would go. For the three currencies I mentioned previously and discuss below, the way to look at these so that they are oriented that a rising foreign currency against the USD shows a rising chart (bottom left to top right, as with AAPL or NFLX) is to type in the currency symbol followed by USD. Thus to see how the Norwegian kroner has fared against the dollar, the symbol is NOKUSD. For the New Zealand dollar against the USD, the symbol is NZDUSD. And for the Brazilian real, the symbol is BRLUSD.

There are of course innumerable forex trading and other sites that provide the information that the Yahoo! sites do. I like Yahoo! because it provides multi-year charts, which most free forex trading sites do not show.


The kroner is a form of petrocurrency, so that provides a hard (liquid) asset behind it. The country has a sovereign wealth fund that has about $100,000 equivalent of financial assets for each citizen. Debt levels are low. Its currency, the kroner, is more attractive to me than that of Sweden, which uses the euro.

Unfortunately for investors, the only ways I know of to invest in Norway's currency are through its bonds and through foreign exchange futures trading, and I don't do the latter. So I have purchased Norwegian bonds, which yield more than U. S. bonds, especially on the shorter end of the curve. Thus I have a yield that is a little more than a U. S. government yields denominated in what I suspect is a somewhat higher-quality bond; and in a currency pair (not shown) that has been relatively stable over many years, with an oil and gas kicker on my side. If the dollar weakens, I get the stated yield plus currency appreciation. If the dollar strengthens, I get the yield minus the kroner's depreciation, but because that might correlate with lower oil prices or, simply, a stronger U. S. economy, I might be happy with the overall situation. That to me is the essence of hedging.

New Zealand

I have nothing against Australia, but I chose the currency of its "twin", New Zealand, instead, due primarily to a housing bubble in "Oz" that may dwarf that of the U. S. (Of course, the countries are quite different and are at their closest point more than 1000 miles apart.)

New Zealand is similar to Norway in population. Both have somewhat over 4 million people. New Zealand continues to have a large agricultural export sector, and I speculate that Asia will continue to expand its real income and thus will place upward pressure on prices for New Zealand animal- and vegetable-based exports.

New Zealand has higher interest rates than Norway and for reasons that are unclear to me, there is enough interest in its currency that an exchange-traded fund with the symbol BNZ exists on the NYSE. Purchase of BNZ exposes an investor to money market-based income available in New Zealand as well as to the fluctuations in the exchange rate between the U. S. dollar and the New Zealand dollar. I own BNZ as well as sovereign debt of New Zealand denominated in New Zealand dollars.

I do not read Norwegian, but I am able to read New Zealand's official documents. Unlike the U. S., the government of N. Z. has an unqualified thumbs up from its auditors. From half a world away, it appears to me as though, similar to the Norwegian government, the N. Z. government is realistic about its finances and has been willing to impose taxes to support its expenditures.

A caution on the BNZ fund. It is not very liquid. Thus it is unsuitable for short-term trading.


Finally, the risk-taking side of my investment nature scoured the globe for suitable high yields. So I settled on Brazil, about which the longstanding joke has been that is has always had a bright future, and always will have one. Well, after a long road back from one of the world's longest-ever bouts with hyperinflation, Brazil now has a low-investment grade rating from three agencies:

Brazil’s credit rating outlook was boosted to positive from stable by Fitch Ratings, which cited the country’s “growth dynamics” and “prudent” policies. Fitch rates Brazil BBB-, the lowest investment-grade rating and in line with rankings from Standard & Poor’s and Moody’s Investors Service.

There is more positive news about Brazil's federal finances. From the IMF's Public Financial Management Blog (click HERE for a link to the general blog site and the headline below for the specific report on Brazil):

With 17 “gold medals” Brazil beats Norway on the PEFA assessment

Gold medals are the objective reference for success in the world of sports. In PFM, you may measure success by the number of “A”s scored on the PEFA assessment. A recent World Bank PEFA report gives Brazil the lead with 17 A's! Even better than solid, dependable Norway! Is the PEFA representation accurate? Is Brazil world leader on PFM, or is reality a bit more complex?

Brazil has been reforming its public financial management systems since the 1980s. The implementation of the fiscal responsibility law (FRL) in 2000 can be considered the major landmark that put the country in the forefront of PFM good practices. The FRL improved substantially the coverage of the budget and fiscal reports, imposed macrofiscal safeguards on debt management and public expenditure, provided for the preparation of a fiscal risk analysis to support the budget process, and pushed for timely and reliable fiscal reports. The impact of the FRL is clearly perceptible in three of the six pillars of the PEFA assessment (credibility of the budget; comprehensiveness and transparency; and accounting; recording; and reporting). From 14 indicators in theses three dimensions Brazil scored “A” in 11.

So this may be a different Brazil from the country that suffered hyperinflation - maybe that was "so last century" . . .

Brazil reports consumer price inflation of about 5% per annum and short-term interest rates more than double that. Thus, similar to that which was in effect required of the U. S. by international lenders after the very weak dollar period in the late 1970s (following prior dollar crises in the 1960s and early 1970s), Brazil may be rewarding investors rather than borrowers by (per official statistics) providing a high "real" rate of return.

Above is a stock chart of an ETF similar to that available for the New Zealand dollar, this one for investment in Brazil's currency, the "real". This ETF has the symbol BZF. It is fairly liquid. The chart shows that this has been a strong performer lately. It may have moved "too much" lately, but that can only be known in retrospect. The Brazilian real remains a little below the highest value it has reached vs. the U. S. dollar in 2008.

It is not easy to directly purchase Brazilian bonds from America. It is possible to purchase transnationally-guaranteed bonds denominated in reals, with a lower yield than Brazilians get, though with principal guaranteed by the transnational organization.

Unlike the "advanced" countries, Brazil has much younger demographics, neither engaged in epidemic mortgage fraud nor reached for yield by buying complex mortgage-related securities emanating from the U. S., and had no banking crisis the last few years. Brazil has a generous helping of natural resources and is not an importer of oil.

Not wasting money on foreign wars or on dead-end expenditures on armaments is good for an economy and therefore a currency's value. Norway, New Zealand and Brazil all are at peace and have no apparent prospect of needing to ramp up their military spending. They have very different economies from each other.

Anyone interested in BNZ or BZF may find detailed information on them at the website of their sponsor, (I have found calling WisdomTree to get a better understanding of these products pleasant and informative.)

Purchase of international bonds naturally requires more advanced brokerage services than purchasing an ETF.

Nothing written here constitutes investment advice to anyone.

Copyright (C) Long Lake LLC 2010

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