Investors in basic materials and oil exchange-traded funds have been getting burned since last spring. And it hasn't been pretty.
Take the United States Oil ETF (NYSE: USO). Since its peak last July at $119 a share, it has fallen to trade around $25. That's a 79% free fall. Even the United States 12-Month Oil ETF (NYSE: USL) has been hit hard. It's the sister ETF, and as the name implies, USL trades in the 12-month oil contract (USO buys the front-month contract). USL has dropped 72% in the same time frame.
But one way to play these two sectors without getting burned quite as much is to use a currency ETF from an Oil-based economy. One of those is the CurrencyShares Canadian Dollar Trust (NYSE: FXC). Since last July, it's down less than 20%.
But a key feature is that the ETF pays a dividend, which has helped cushion the market's drop. How much? Roughly eight percentage points, leaving investors with a net loss since last summer of around 12%.
Preparing For Inflation
Remember that interest rates are extremely low right now. And that's worldwide. As those rates go up—as they should considering the vast amount of government stimulus being pumped into markets around the globe—one way to play inflation is to take a look at Materials-based currencies.
Those would include FXC and the CurrencyShares Australian Dollar Trust (NYSE: FXA). Both would be an alternative means of harnessing any economic rebound with significantly less risk than holding individual stocks or stock funds.
Materials figure to be a major winner in any comeback in the markets. This year, the Materials Select Sector SPDR (NYSE: XLB) had fallen in price 19.5% through early Tuesday. By comparison, FXA had sunk just about 10%. Australia, of course, is a major world supplier of Basic Materials and represents a big trading partner of China's and other key Asian markets.
Other Currency ETFs To Watch
But if you're not ready to take the plunge into a recovery yet, then it's worth noting that the PowerShares DB U.S. Dollar Index Bullish (NYSE: UUP) is up 8.5% for the year. However, most of that positive performance is coming as a result of mass hysteria. So a way to hedge any bets on FXC or FXA is to add a little UUP.
It's hard to believe that the U.S. dollar will continue to soar at current rates throughout 2009. The enormous amount of debt this country's incurring has to result in some downside for investors. Still, right now, UUP technically looks great. On Monday, as stock markets were tumbling, the ETF broke to new recent highs. And UUP appears to have plenty of room to run.
Another currency ETF to keep an eye on might be the CurrencyShares Mexican Peso Trust (NYSE: FXM). Technically, this fund has been broken since last August. But it represents a country with a strong Basic Materials-based economy. So if a rebound takes place, Mexico's close ties with the U.S. and its rich oil reserves and metals market could be another winner. However, one caveat with this ETF is that the peso carries political risks you won't find with the Canadian and Australian dollars.
The Case For China
Besides the U.S. dollar, China's currency ETF is also showing strength. The WisdomTree Dreyfus Chinese Yuan (NYSE: CYB) is up 1.70% this year. Also, the Market Vectors Renminbi/USD Exchange-Traded Note (NYSE: CNY) has gained 1.90% in 2009. Both track China's modified free-floating currency markets.
We don't own either CYB or CNY at the moment in our currency models for clients, mainly because we're not convinced China's economic problems are behind it. And both funds are trading in tight ranges right now. If either breaks out at some point with a little more trading volume, we'd probably favor going long on these.
At the moment, CYB trades an average of 18,000 shares a day, while CNY trades about 3,300 a day. Each has shown significantly higher volume at times. Right now, these are just too thinly traded portfolios. We'd like to see an average daily volume of at least 100,000 shares.
For an individual investor, it might make sense to dip into CYB or CNY as long as they're trading two- to three-times the size of their purchase amount. So if you're buying 1,000 shares of CNY, you might want to wait until volume averages around 3,000 shares traded—which is where it is today.
So it just depends on how big of a splash you want to make. With larger purchases of currency ETFs and ETNs, it can be much easier to get in than to get out of positions.
The issue is with spreads between bid/ask prices. For example, CNY right now has an 18-cent spread. But CYB, with more volume, has a 4-cent spread. Consider that the most heavily traded currency ETF, UUP, has a penny spread now. It trades nearly 600,000 shares a day.
Anthony Welch is a portfolio manager and co-founder of Sarasota Capital Strategies in Osprey, Fla. The ETF strategist welcomes comments and suggestions for future columns at: firstname.lastname@example.org.
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