These days, making a buck in the market isn’t as easy as it used to be.
The major market averages just logged their worst October performance since 1987, and unless you’ve been short for the past several months, you’ve likely been caught on the wrong side of the trade more than a few times.
Indeed, investors are still running for the exits, and it’s hard to blame them. Nearly every economic metric out there looks dismal, and as far as I can tell, those metrics aren’t likely to improve substantially anytime soon.
There is, however, a segment of the market that has staged a somewhat counterintuitive bull run dating back to July. That segment is the value of the U.S. dollar versus rival foreign currencies.
Take a look at this chart of the U.S. Dollar Index, a measure of the value of the greenback versus a basket of six major foreign currencies.
As you can see, the dollar bull began running in July, but it really headed for the races in August. September saw the dollar correct sharply, but since the September low, we’ve witnessed a big surge higher in the greenback.
So, how can we make a buck off, well, this running buck? Simple — by using an exchange-traded fund (ETF) designed to move higher along with the trend in the dollar.
The Long and Short of It
Thanks to Deutsche Bank (DB) unit PowerShares Capital Management LLC, investors have an excellent ETF designed to move in concert with the greenback. That ETF is the PowerShares DB U.S. Dollar Bullish Fund (UUP).
The chart below of UUP shows how closely this ETF tracks the performance of the U.S. Dollar Index.
Through the use of long futures contracts on the Deutsche Bank U.S. Dollar Index, the fund is designed to replicate performance that is akin to being long the dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
So far, so good, if the greenback keeps up its blistering pace and continues heading higher.
But what if the ink starts to dull on the greenback? What happens if, and when, the dollar reverts to the dismal doldrums of the past?
Enter the PowerShares DB U.S. Dollar Bearish Fund (UDN).
This ETF represents the flipside of the UPP coin. With UDN, you get performance that is inversely correlated to the movement of the U.S. Dollar Index.
Like UPP, UDN uses futures contracts on the Deutsche Bank U.S. Dollar Index to achieve its objective, only its contracts are akin to being short the Dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
Simply put, when the dollar rises versus the aforementioned basket of global currencies, UPP adds a few coins to your purse. Conversely, when the dollar falls versus those same currencies, UDN is going to put a few shekels in your pocket.
Why the High Times for the Greenback?
Now that you know how well the dollar has performed recently, and now that you have the tools to go buck wild whether the dollar rises or falls, we have to asses the reasons why the greenback has done so well during the past several months.
By determining the why of the dollar’s high times, we can better understand and predict when those high times might start to come down.
One reason for the big run in the dollar is safety.
Despite a rocky equity market here in the United States, the rest of the world has also been the victim of the equity meltdown. In fact, most global markets — and especially emerging markets — have seen a much more severe sell-off than what’s taken place in the U.S. equity markets. As investors continue fleeing foreign markets, their money has kept on migrating to the stability and safety of the greenback.
In addition to the safe-haven buying we’ve seen in the dollar, we’re also seeing depreciation in foreign currencies thanks to the recent round of interest rate cuts by central banks around the globe.
Switzerland, Canada, Sweden, the Bank of England and the European Central Bank all cut their rates in an effort to pump liquidity into the world’s financial system. An interest rate cut is usually detrimental to a currency’s value because, in essence, you are making that currency cheaper by lowering the cost of borrowing.
One other factor helping to pump up the dollar’s value is the unwillingness on the part of banks to lend money due to the credit crisis. And while this unwillingness to lend is generally considered a pernicious influence on the economy at large, it has had the perverse effect of shrinking the supply of U.S. dollars in foreign markets.
Until lenders start to do what they do best and actually start loaning money, the dollar is bound to be the beneficiary of constricted supply.
For sure, all of these bullish influences on the dollar are somewhat frangible. Given the sharp rise higher in the greenback lately, I wouldn’t be surprised if we see a rapid pullback before too long. Having said that, those investors who owned UPP for the past several months are watching their portfolios go buck wild.
Of course, when the tide turns and when the world loses its appetite for greenbacks, those holding UUP will find they have less coinage. When that happens, the simple fix is to shift your mindset and take flight into UDN.
Finally, always remember that when it comes to making a buck, objectivity is your best friend. Get your money long the greenback while it continues running, but don’t hesitate to go short when the dollar trips and falls.
Jim Woods is a Senior Editor for OptionsZone.com. To learn more about him, read his bio here.
