Take it from Wayne Gretzky: In your portfolio, as in hockey, you want to skate to where the puck is going, not to where it's been. So even though the U.S. dollar has moved higher over the past year, you should follow the economic clues that point in the opposite direction: down.
The hefty U.S. current-account deficit, which clocked in at $673 billion in 2008, tells much of the story. That figure represents the difference between what the U.S. pays other countries for goods, services and income from investments, and what it receives from other countries.
As Axel Merk, chief investment officer and president of Merk Investments, explains, the gap implies that foreign investors have to purchase about $2 billion of dollar-denominated assets every day just to keep the dollar from falling.
Foreigners gladly snapped up dollar-denominated assets, particularly Treasury bills and bonds, in late 2008 and early 2009, when financial Armageddon loomed. The dollar is, after all, still the world's reserve currency and is considered highly safe. That flight to safety fueled a 25% rise in the value of the greenback measured against a basket of developed-market currencies over the year that ended March 5.
But now that Armageddon is off the table, foreign investors have reversed course. In April, foreign governments bought a net $8.3 billion of U.S. Treasury securities, down from $50.5 billion the month before. In total, foreign investors sold a net $53.2 billion of dollar-denominated securities in April.
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This trend will continue even if the dollar retains its status as the world's reserve currency. As bond guru Bill Gross, chief investment officer of Pimco, wrote in a recent commentary on his firm's Web site, "Holders of dollars should diversify their own (currency) baskets before central banks and sovereign wealth funds ultimately do the same."
This does not mean you should move your retirement savings into the Chinese renminbi. After all, you probably earn and spend most of your money in dollars.
But diversifying the portion of your portfolio you keep in bonds or cash with a fund that benefits from a falling dollar could make you some money -- and provide disaster insurance against the unlikely scenario of a dollar crash.
One ETF, 3 mutual funds
PowerShares DB U.S. Dollar Index Bearish (UDN, news, msgs) is a good choice for a simple, low-cost hedge. The exchange-traded fund is designed to go up when the U.S. dollar index -- which measures the dollar against a basket of six developed-market currencies -- goes down. The fund, which achieves its objectives by selling short currency-index futures, charges annual expenses of 0.5%.But there's something to be said for letting a warm body pick currencies for you. Axel Merk has an excellent record of doing so in Merk Hard Currency (MERKX). From the fund's inception in May 2005 through June 17, it has gained an average 5.6% per year. During the same period, the inverse of the U.S. dollar index gained 1.2% a year.
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Protect yourself from the dollar's decayCurrency analyst and fund manager Axel Merk says the dollar will stay under pressure and tells what investors should do for protection. (May 14)
Merk crafts the fund with the specific aim of hedging the U.S. dollar. He'll invest in short-term money-market securities to play currencies he likes."We try to avoid interest-rate risk and credit risk," he says.
Recently, he also had 14% of the portfolio stashed in gold. Merk likes the Norwegian krone because of that country's healthy economy, and he favors the Canadian and Australian dollars as beneficiaries of rising oil prices. The fund charges 1.3% in annual expenses.
Continued: A fund with a bit more oomph
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