Make Better Moves Into Currencies

Another vehicle that has become popular in the last year or two is the (MERKX Quote)Merk Hard Currency Fund, a more broad-based choice for such exposure (it holds multiple foreign currencies, plus gold). But the fund's annual expense ratio of 1.3% is astronomical when compared with the foreign-currency ETFs. Further, it's difficult to get an answer from customer service about the fund's dividend or even its dividend policy.

There remains much debate today about the wave of ETF launches we're witnessing and whether it amounts to overkill. There have been and will be more silly offerings, but there exist, of course, very useful ETFs, and the foreign-currency exchange-traded funds certainly fit in that category.

One note: Because of the often volatile nature of currency trading, I believe investors should use currency ETFs as part of their overall foreign exposure, not count it as some part of their cash allocation.

All in the Timing

If one is thinking of increasing his or her foreign currency exposure at the moment, how does that timing look? In short: not bad.

Any decision to own foreign currency is really a negative bet on the U.S. dollar, so a look at this currency is key. In the chart below (a three-year daily USD index), it seems the greenback has just rallied from an extremely oversold condition back to an area that should provide some resistance.

While we might be witnessing a decent entry point for non-U.S. dollar exposure as a result, such investors should prepare themselves for less heady gains than foreign currencies saw in 2006 for two key reasons:

First, with each passing day it looks less and less likely that the Fed is going to be forced to cut interest rates soon due to economic weakness. Fear of such a cut and its impact on the dollar is what drove it to recent lows; major slippage in the greenback from here, then, looks unlikely in the near term.

Second, it is a positive, technically, that the dollar's recent low went unconfirmed by important short-term indicators. Such action suggests that the move in the dollar index down to 82.5 may stand as the low for some time to come.

Fundamental and technical support below, yet chart resistance above? We could be in for some boring weeks and months on the currency front, which many market participants would consider a welcome relief.

Investors, then, should expect the yield component of any foreign currency holding to be the main driver in the short run, which makes the price differences between the products outlined above all the more important.