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ETF Winners of the “U.S. Dollar Carry Trade”

17 September 2009 at 4:05 pm by Gary Gordon     Bookmark and Share    Follow EtfExpert on Twitter

The mainstream media continue to foster a notion that improving economic fundamentals are driving the cyclical bull. If that were the case,¬†treasury bond yields wouldn’t be falling¬†and gold wouldn’t be¬†maintaining at the¬†$1000 per ounce level.

If economic fundamentals were as sound as the media would have you believe,¬†insiders at Toll Brothers wouldn’t be selling shares of their own company.¬†For that matter,¬†conventional mortgage rates wouldn’t be back at¬†5% and¬†real estate organizations wouldn’t be begging for a continuation of the homebuyer credit.

I’ve pondered the simulateneous rise in gold, U.S. stocks, and U.S. treasury bond prices. I’ve wondered how 3 very different asset classes could move in the same direction for 3+ months… and do so as the U.S. dollar drops to new depths day after day.

And I’ve finally come to a conclusion: This is the return of “a” carry trade.

No, it’s not the infamous yen carry trade, where investors borrowed the Japanese dollar at negligible interest rates to invest in the higher-yielding Australian and New Zealand dollars. This is the U.S. dollar carry trade… and it may be far more dangerous.

In the yen carry trade, you had a stable currency (yen) that yielded nothing and was easy to borrow. You borrowed from one stable G-10 currency and invested in a higher-yielding G-10 currency to capture the income difference… pretty simple;¬†that is, things were going along smoothly until an international credit crisis caused the yen’s rapid appreciation¬†such that investors scrambled to¬†pay back the loans.

Today, however, the U.S. dollar is both cheap, easy to borrow, and “counted on” to fall in value. It’s replaced the¬†yen as a preferred funding source to¬†buy the¬†reasonably stable Australian dollar and/or New Zealand dollar. Not only¬†do you get the income difference, but you’re getting the appreciation of the Aussie dollar¬†versus the U.S. dollar. It’s a double win! (At least that’s the perception!)

And therein lies the danger. Some investors around the world may ratchet up the risk by using leverage to make this investment.

Granted, the prospects for the Aussie dollar look good, as interest rates in Australia are likely to rise in the near future. And the prospects for the¬†U.S. dollar¬†look bad, as U.S. interest rates won’t be rising in¬†the foreseeable future.

Nevertheless, if the U.S. dollar were to suddenly come back into favor, due to any reason (e.g., risk aversion, government intervention, policy change, etc.), investors could rapidly sell off the stocks, currencies and other assets they’ve been buying with¬†borrowed greenbacks.

For now, though, the ETF winners of the U.S. dollar carry trade are:

1. Currency Shares Australia Dollar Trust (FXA)… 22% YTD.

2. WisdomTree New Zealand Dollar (BNZ)… 23% YTD.

3. PowerShares G-10 Currency Harvest Fund (DBV)… the only carry trade fund¬†borrows the 3 lowest yielding currencies and invests in the 3 highest yielding currencies.

4. iShares MSCI Australia Fund (EWA)… the rapid fire ascent of the Aussie dollar is giving an even bigger boost to foreign stocks, as Australian companies earn profits in ever-appreciating Aussie dollars.

5. iShares MSCI All-World Index (ACWI). The entire stock asset class is benefiting from folks borrowing the cheap U.S. dollar around the world and putting that money to work. For now!

If you‚Äôd like to learn more about ETF investing‚Ķ¬†then tune into¬†‚ÄĚIn the Money With Gary Gordon.‚ÄĚ You can listen to the show ‚ÄúLIVE‚ÄĚ,¬†via podcast or on your iPod.

Disclosure Statement: ETF Expert¬†is a web log (‚ÄĚblog‚ÄĚ) that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Adviser 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.

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2 Responses to “ETF Winners of the “U.S. Dollar Carry Trade””

  1. Dave says:

    ICI is another carry trade fund

  2. Staff says:

    The iPath Optimized Currency ETN (ICI) is an exchange-traded “carry trade” vehicle. However, it is not a “fund.” Investors need to recognize the unique credit risk associated with “exchange-traded notes.”


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