ETF Expert

Prior to the credit collapse, the "yen carry trade" was a popular method for making easy money. It essentially involved borrowing currencies from low interest rate countries like Japan and investing in higher-interest rate countries like New Zealand and Australia. After all, how could you go wrong by borrowing for 0%-.5% in Japan's currency and investing in higher yielding instruments elsewhere? (Famous last words!)

As any doom-n-gloomer can now tell you, this came to a very painful conclusion. During the credit crisis, the yen's currency strengthened immensely as Australian dollars and New Zealand dollars declined rapidly. Borrowers had to quickly repay those borrowed yen loans to avoid further losses, further strengthening the yen in a self-fulfilling prophecy-like fashion.

Yet a curious thing has been happening lately. The Japanese currency via CurrencyShares Yen Trust (FXY) has pulled back 12% off its highs. That alone may suggest a bit more risk-taking in general, as I wrote about in February. (See "What the Yen's 10%+ Drop May Be Telling Us.") However, it may also foretell the return of a "Strategy ETF" that mimics the carry trade approach.

The PowerShares DB G10 Currency Harvest Fund (DBV) is up 2% YTD. It has gains in all of the major momentum periods, including 1-week, 4-weeks, 8-weeks and 12-weeks. It also moved significantly above its 50-day, exponential moving average.

This index is made up of long futures positions on three currencies with the highest interest rates and short futures positions on three currencies associated with the lowest interest rates. This has the effect of compiling an excess return from the differences between today's 3% in Australia and potentially 0%-.25% in Japan or the U.S.

Shorting the yen and the U.S dollar during the height of the credit crisis was somewhat of a disaster, as both currencies appreciated markedly. Yet forward thinkers may be looking ahead to a time when the U.S. dollar may resume a downward trend and a time when neither the U.S. nor Japan will be in a position to raise interest rates. Meanwhile, Australia, New Zealand, Norway… even the European Monetary Union might be in a better position to do so.

It follows that while the excess return may not seem like much, the yen carry trade worked beautifully for years. Due to Japan's extreme export-related economy, it's going to keep its yen in check through any measure possible. And the U.S.? Too much strength in the dollar only further hampers U.S. exporters at a time when we need our exporters to deliver for the U.S. economy.

Net result? The PowerShares DB G10 Currency Harvest Fund (DBV) will probably be shorting the yen and the U.S dollar, while going long on Australia, Norway and New Zealand. Will it work out? I'd give it a reasonable shot at success.

However, the yen must continue to depreciate from current levels. If the CurrencyShares Yen Trust (FXY) can drop below its long-term 200-day moving average and stay below for a period, the PowerShares DB G10 Currency Harvest Fund (DBV) should benefit handsomely. Moreover, if you believe that the yen will depreciate, there's the ProShares UltraShort Yen (YCS) available as well.

If you'd like to learn more about ETF investing… then tune into "In the Money With Gary Gordon." You can listen to the show "live" or via podcast or on your iPod at this link.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.