Diversifying Portfolio Cash – Part 2

The best way to diversify currencies is pretty quickly and in small increments. After all, the whole point is to hedge existing one-currency exposure. It is the existing exposure that is risky. That said, obvious scaling-in rules apply. Never buy on an uptick. Try to buy on a down day without headlines that may indicate a bigger problem. And go slow (ie underweight or zero-weight) with any currency that does seem to have some headline/”crisis” risk.

When I talk of a currency, I am really talking about a currency pair. Currencies have no absolute value. Only a value relative to another currency. In my case, the US$ is the implicit default currency, so the currency pair is the discussed currency v US$. That is what each ETF is – a currency pair.

British Pound (FXB) — Long-term (ie cash as “savings”), I don’t see much difference between the pound and the dollar. Neither are currencies worth “saving”. Shorter-term (ie cash as “liquidity”), the British government is implementing fiscal austerity which should be a positive for the currency. The Bank of England is a potentially serious “quantitative easer” (but really — how much different than Helicopter Ben) so some currency risk there. Overall debt/leverage problems are a bit worse than US. Trade deficit with the countries not included in any “cash” ETF is much improved from a couple of years ago so a positive for the currency but watch this carefully. Pound-zone equities tend to be either defensive or commodity (positive for currency) or financial (potentially ugly – but they produce a current account surplus). Technicals on all these in part 3.

Euro (FXE) — Long-term, I don’t see much difference between euro and dollar. Both are trash. Euro is structurally unsound and will likely disappear at some point — but it would be dangerous to see the stresses as fundamentally different from the US (California is not too different from Greece) or to underestimate how much the different countries intend to remain currency linked. Shorter-term – there is clear headline risk re sovereign bonds right now but FXE ain’t sovereign bonds. It is the euro currency. This headline risk has potentially created a valuation opportunity. The ECB is hawkish and euro-zone fiscal policy is tending towards at least the appearance of austerity. That is positive for the fundamental value of the currency. Debt/leverage problems are a little bit worse than the US. The eurozone actually runs a trade surplus or is trade neutral with the rest of the world so this is a positive for the currency. Eurozone equities are diverse but the austerity measures are gonna hurt those euro alternatives. Overall, the current headline risk that the eurozone is undergoing has created an opportunity. The only reason the euro might go to parity with the dollar is if one believes that the US is growing, exporting and with the fed/states in good shape with no headline risk to come here. That said, the volatility is likely to continue so any scale-in should be piecemeal.

Swiss franc (FXF) – Long-term, the swissie is “savings” eligible — though risky. The Swiss culturally understand the value of a hard currency — and as long as Germany is in the euro, they will also get the currency inflows from those Germans who believe in a hard currency. That is also the source of risk however. The German government is already blasting the Swiss for “helping tax evaders” and if Swiss banking privacy disappears under that pressure then so does the “savings” value of the Swiss franc. Short-term, the swissie has benefited from eurozone problems but Swiss banks are as exposed to Eurodebt as Eurobanks are. And Swiss bank debt is high enough to potentially create bailout/etc problems for the currency. Public debt isn’t a problem. Trade flows aren’t a problem since it is mostly eurozone based or benefits from a strong currency.

Japanese yen (FXY) – Long-term, the yen is a bug in search of a windshield. But until Japanese savings rates change, it won’t get hit. And even then, it’s hard to know how it will unfold. Until then, Japan will remain the major capital provider to Asia — and they will choose whether to invest yen or dollars. So it is imperative that one own yen to hedge that decision. Short-term – Japanese debt problems are enormous – but they have been for a long time and in a very real sense their debt problems are actually our problem since much of their debt is backed by dollar reserves. Trade surplus is a positive for the currency. BoJ is a frequent currency manipulator. Whenever the yen gets too strong, they intervene by buying dollars (or some other reserve currency) and issuing yen. The best way to buy FXY yen is to wait until they intervene to drive down the yen – and then buy yen with newly appreciated dollars.

Australian dollar (FXA) – Long-term, the A$ is savings-eligible. It is almost the definition of a commodity-backed currency unlinked to the US$ and issued by a sovereign with very very low debt. That said, it is commodity-based and therefore is only savings-eligible when commodity prices themselves are at very low prices. Otherwise, the A$ is not “savings” but is merely riding the short-term momentum of commodity prices. Short-term – commodity prices have created a serious housing bubble problem in Oz. If/when that bubble breaks, watch out. Trade balance is volatile but not a structural problem.

Canadian dollar (FXC) – Long-term, the C$ is savings-eligible but risky. Like the A$, it is almost commodity-backed – but heavily riding along the US$ – and with some potential debt problems. Short-term – like Oz, Canada now has a housing bubble which looks like it’s about to break. Trade balance is overwhelmingly trade with the US and/or commodities (trade surplus) elsewhere.

Last part (this weekend) will deal with technicals for these ETF’s.

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