ETF XRAY

Unwinding of Carry Trade Affects ETFs

Part of the recent volatility in financial markets and country exchange-traded funds was the unwinding of carry trades where investors borrowed in low interest rate countries like the Japanese yen and Swiss franc and invested in high interest rate countries like the UK, Australia and New Zealand.

Market volatility increased very sharply this week with the dollar posting net gains despite the large disparity in moves against individual currencies. The main reason was a massive liquidation of carry trades as margin calls forced investors to close and unwind these trades.

The yen gained sharply during the week due to an exodus from carry trades as credit fears intensified. The Japanese currency pushed to highs around 112.0 against the dollar after the biggest one-day gain since 1998. The yen also gained rapidly against the Euro with a peak beyond 150.0 while Sterling weakened to an 11-month low below 225.0 against the yen. The Swiss franc also secured gains against the Euro with a move to highs beyond 1.62. The net affect was a strengthening of the Japanese yen ETF (FXY) and a pullback in Australia (EWA) and the UK (EWU).

The Australian dollar suffered very sharp losses over the week with a decline to lows around 0.7700 against the US dollar with a particularly rapid decline on Thursday as global credit conditions deteriorated. The currency was undermined by a sharp reduction in carry trades and Australian financial asset losses with a flow of funds back to Japan as global stock markets fell sharply.

The US greenback gained strong support from its key role as a reserve currency, especially as emerging-market currencies came under heavy pressure over the second half of the week. There was a repatriation of investment to the US while wider positions betting against the dollar were pulled back.

Find out how you can best position your portfolio to adopt to fast changing market conditions by joining the Chartwell ETF Advisor

ETF Options for Falling U.S. Dollar

The US dollar has fallen 4.5 % against the euro this year and 4 per cent against sterling, hitting a new 26-year low against the pound last week. The trade-weighted dollar index dropped to its lowest since 1992. This dollar weakness translates into a boost in performance for international and country-specific ETFs.

The reasons for continued dollar weakness include a US economy growing more slowly than many global rivals and interest rates rising fast outside the US while domestic rates remain flat not to mention anxiety over US credit and mortgage markets.

The easiest way to play the weak dollar trend is with international or country-specific ETFs. They are not hedged against the dollar so that strength in the underlying currency, such as a stronger Singapore dollar captured through the Singapore ETF (EWS), boosts returns for U.S. dollar-based investors.

Rydex also offers a series of foreign currency ETFs such as the CurrencyShares British Pound Sterling (FXB), the CurrencyShares Euro (FXE), and the CurrencyShares Canadian Dollar (FXC).

A couple of Chartwell's seven model ETF portfolios have a small position in PowerShares DB G10 Currency Harvest (DBV) which is up 14% year-to-date. It tracks 10 currencies, going long on the three top tier currencies with the highest interest rates and going short on three currencies with the lowest interest rates. DBV is currently long on the Australian dollar, the New Zealand dollar and the Pound sterling and short on the Japanese yen, the Swiss franc and the Swedish kroner.

This is not a bad return but relying primarily on interest rates ignores other key factors. It is also a good idea to have some emerging market currency plays in your portfolio. Take for example, the Brazilian real and the Brazil iShare (EWZ). Brazil has been on a spree of cutting interest rates over the past two years and its currency has strengthened considerably. Consumer demand, exports, and investment have been fueling economic growth and a stronger currency has helped keep a lid on inflation. The real has appreciated against the US dollar from R3.95 to one dollar in late 2002 to R1.86 to one dollar last week.

Then there is the PowerShares U.S. Dollar Bearish Fund (UDN) that track the New York Board of Trades U.S. Dollar Index. This index is the most popular measure of the dollar against other currencies; the Euro has a 58% position; Japanese yen 14%; British pound 12%; Canadian dollar 9%; Swedish krona 9%; Swiss franc 3%.

By Carl Delfeld of the Chartwell ETF Advisor

Does a Weak Dollar Help US ETFs?

How do changes in the value affect US companies and US exchange-traded funds? It is not as straight forward as it looks. First, a falling dollar raises the dollar value of foreign sales. Big US multinationals receive roughly half of their total sales from overseas. For S&P 500 companies it is about 30 per cent of their sales overseas compared with 15 per cent for smaller companies in the Russell 2000) When the dollar weakens, the value of those sales grows. Hence international “mega-cap” companies, laggards for years, have recently outperformed. A weak dollar im­proves the case for big US stocks.

But as John Authers points out, globalization also affects costs and the proportion of cots a company decuts from revenue to determine profitability. Plus, look at Europe, the stronger euro has not hurt their share prices even though they are even more international in terms of sales than most American firms.

One of the reasons European ETFs are doing so well this year is the stronger Euro. Remember, international ETFs are not hedged against the US dollar so a weaker dollar will help their returns.

By Carl Delfeld of the Chartwell ETF Advisor

CurrencyShares Euro Trust (FXE)

The euro is the currency of thirteen European Union countries, stretching from the Mediterranean to the Arctic Circle (namely Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, Slovenia and Finland).
Euro banknotes and coins have been in circulation since 1 January 2002 and are now a part of daily life for 315 million Europeans living in the euro area.

(Click on image for larger view)

DE Smith of

CurrencyShares Canadian Dollar Trust (FXC)

The Canadian dollar has had a nice ralley over the last four weeks. It may surprise some that Canada is the second-largest country in the world; only Russia is bigger. Thirty-five million people live in the ten Canadian provinces and three territories.

ETFs for Dollar Bulls and Bears

Now ETF investors have a couple more tools to build a global ETF hedge portfolio. No matter whether you are a dollar bull or bear, you can hedge or profit from the dollar's direction, ETFs designed to let investors play currency markets around the world without opening a futures account.

Deutsche Bank AG and Amvescap PLC unit PowerShares Capital Management LLC listed the new ETFs Tuesday -- the PowerShares DB U.S. Dollar Bullish Fund (UUP) and the PowerShares DB U.S. Dollar Bearish Fund (UDN) -- on the American Stock Exchange. The ETFs are designed to take long or short positions in the Deutsche Bank U.S. Dollar Index Futures Index -- Excess Return, which follows the movement of the U.S. dollar against a basket of six major currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc. Both new ETFs have expense ratios of 0.55%, but that will be offset by the yield from the fixed-income securities they hold as collateral for the futures contracts

A Currency Harvesting ETF

By Carl Delfeld of the Chartwell ETF Advisor

While the Rydex CurrencyShares ETFs allow investors the opportunity to bet on seven different forign curencies, the DB G10 Currency Harvest ETF (DBV) seeks to track the Deutsche Bank G10 Currency Future Harvest Index™ by (1) entering into long futures contracts on the three G10 currencies associated with the highest interest rates, (2) entering into short futures contracts on the three G10 currencies associated with the lowest interest rates, and (3) collateralizing the futures contracts with United States 3-month Treasury bills.

If the United States Dollar is one of the six currencies associated with the highest or lowest interest rates, the Fund will not establish a long or short futures position in USD because USD is the Fund's home currency.