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Buying an International ETF? Check the Currency First

Stocks in this article: FXY DXJ EWU FXB SPY DBUK FXE HEDJ VGK

NEW YORK ( ETF Expert) -- Nobody may have any interest in shorting the U.S. stock market right now. Yet, futures traders are growing increasingly excited about the prospect of shorting certain currencies.

In particular, bets that the Japanese yen will fall against the greenback are at their highest levels since the summer of 2007. Granted, a contrarian might think that a high degree of short interest is an indication that Japan's currency could actually strengthen against the dollar. However, trend analysis suggests otherwise.

The price of the CurrencyShares Japanese Yen Trust (FXY) is below both its 50-day and 200-day moving averages. For most trend followers, this suggests that yen depreciation may have further to go. From my vantage point, though, I would need to see the yen break through the 52-week lows set back in May.

If that turned out to be the case, I might anticipate capital appreciation from WisdomTree Japan Hedged Equity (DXJ). The exchange-traded tracker has had a difficult time recapturing its springtime highs due to the fact that the yen has not quite capitulated.

In a hedged equity investment like DXJ, one garners the benefits of Japan's heightened capacity to export without losing money alongside a depreciating currency. In an unhedged equity investment like iShares MSCI United Kingdom (EWU), however, one might find he/she is underperforming when the underlying currency (i.e. British pound) is at a year-to-date peak. Notice in the chart below that the current price of CurrencyShares British Pound (FXB) is back at 2013 highs and that its 50-day moving average crossed above its 200-day moving average in mid-September. Since the cross-over, SPDR Trust S&P 500 (SPY) has gained 5.9% whereas EWU has only tacked on 2.5%.

While an investor in EWU is getting a currency lift in his/her investment when the British pound rises against the U.S. dollar, he/she is bumping up against the perception that British companies in EWU's basket cannot perform well when the pound is reaching new heights. Personally, I expect the pound to lose value as Federal Reserve tapering concerns begin taking a toll on the euro, pound and yen. Yet the technical evidence for a weaker British pound has not yet materialized.

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