Hedging Against a Dollar Dive

Among the gloom-and-doom scenarios for 2006, a decline in the dollar ranks high. If this pans out, as I expect, exposure to a currency product will make a lot of sense for U.S. investors.

There are a number of currency products on the market now that would benefit, one way or another, if the dollar drops.

Each share in the Rydex Euro Currency Trust (FXE Quote) represents ownership of 100 euros. The ETF pays a small but fluctuating interest rate, deducting a 0.4% fee from the interest paid. The euro could rise against the greenback because the Federal Reserve is close to the end of its tightening cycle while the European Central Bank just started to tighten. As the spread between the fed funds rate and the ECB overnight rate narrows, the euro could rally.

There are a number of open-ended mutual funds as well. ProFunds Falling U.S. Dollar (FDPIX) and Rydex Weakening Dollar (RYWBX) are indexed to the NYBOT U.S. Dollar Index (USDX). The dollar index also has a heavy weighting in euros (57%) as well as exposure to the yen, British pound and Canadian dollar, among others. ProFunds Falling U.S. Dollar is meant to deliver the inverse of the dollar index's performance and the Rydex Weakening Dollar Fund is leveraged to deliver double that.

The Merk Hard Currency Fund (MERKX) is an actively-managed fund with exposure to the Swiss franc and Australian dollar. In addition to currencies, the fund also owns foreign bonds and streetTRACKS Gold (GLD Quote) shares.

The Franklin Templeton Hard Currency Fund (ICHHX) is also actively managed. As of its most recent reporting, it owned foreign treasury bills and currency swaps, but no bonds or other products like the Merk fund. Its focus is primarily European, with a little Canadian and Singaporean exposure.

Citigroup offers two structured products that are very similar: Currency Linked Principal Protected Notes Based upon a Group of Five Asian Currencies (CZJ Quote) and Principal Protected Notes based upon a group of Asian Currencies (CAQ Quote). Both are pegged to baskets of Asian currencies, excluding the Japanese yen. They both mature in 2008 and are scheduled to return a minimum of $10 a share if the Asian baskets don't appreciate against the dollar and more than $10 if the baskets do appreciate in value. These products can be more complicated than they seem and time must be spent with the prospectus.