Hedging Against a Dollar Dive

Here are eight financial products that would benefit from a weakening greenback.
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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) - Get Report

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) - Get Report

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)

and

Principal Protected Notes based upon a group of Asian Currencies

(CAQ)

. 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.

The most interesting option to me right now is the

PIMCO Developing Local Markets Fund

(PLMIX). This open-ended mutual fund has exposure to more than 30 foreign countries, including many emerging market currencies.

My thesis for thinking that this type of product has a place in a diversified portfolio has several catalysts:

Some large oil exporters, most notably Russia, have publicly talked about currency diversification of their petrodollars into other currencies besides the dollar.

The continued global demand growth for natural resources from countries like Australia and South Africa means that capital will flow into their currencies, possibly at the expense of the greenback.

The yield differential the U.S. currently enjoys over Europe could decrease.

The U.S. debt and deficits should cause the dollar to weaken.

All of these issues have been nagging concerns for a while. Another issue I have been thinking about lately is the investment product innovation occurring elsewhere, specifically in the U.K. The London Stock Exchange debuted a gold ETF before the U.S. and has a crude oil ETF -- the U.S. has none. Also, the LSE is winning listings from companies in hot investment destinations like Turkey's Turkiye Is Bankasi AS and Poland's Bank Pekao. The LSE will also have the OAO Rosneft IPO (Rosneft was the "winner" in the Yukos saga).

The point is that as capital markets globalize, we could see that the U.S. does not have to be the primary market. As other countries catch up economically, there will be less demand for dollars from the world investment community. This could spill over into below-average stock market returns in the U.S.

I believe that the sum of all of this is a weaker dollar in the years to come. Exposure to a currency-based product could help balance out this risk.

At the time of publication, Nusbaum was long Citibank Principal Protected Notes based upon a group of Asian Currencies, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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