Best to Be Wary Before Pouncing on Dollar's Loss

Trades on Currency Can Prove Complex

Can you turn the dollar's loss into your gain?

If it's crossed your mind, analysts and investment strategists have one thing to say to you: Watch out.

"Currencies are inherently very volatile, and they can move rapidly," said Gary Cloud, a portfolio manager of the AFBA 5-Star Balanced Fund in Alexandria.

The dollar staged a stunning recovery this summer after starting the year at a multiyear low. Between July and November, it climbed about 24 percent against a basket of six major world currencies. Then last week, the dollar had one of its biggest one-day drops against the euro and plunged to a 13-year low against the Japanese yen.

"Investing in the dollar as an asset class is a complex strategy, and I would say is not for the average investor without professional assistance," said Mickey Cargile, managing partner of WNB Private Client Services in Texas. "However, if one is a speculator or a sophisticated investor, it does present opportunity."

When playing currencies, you bet not only on the direction of your foreign investment -- a bond or stock -- but also on the fluctuation of the currency. It's a double gamble.

"The real winner is when the asset class that you buy goes up and the dollar compared to the currency of the asset you bought goes down. That's when you get the two for one," Cloud said. "The currency return can have a huge impact on the overall return of the asset you're buying. And it can work for you and it can work against you."

Making it work is tricky -- and requires an ability to predict the future. Right now, according to Paul Hickey, managing partner of Bespoke Investment Group, a financial research firm, the dollar is technically in a rally, despite its losses last week.

"We've only had one week of weaknesses," he said. "We wouldn't be ready to quite say the dollar's rally from July is over."

But ask Dan Seiver, a finance professor at San Diego State University, and you'll hear the dollar's rally is over. "It probably still has a fair amount to fall," he said.

The dollar's value spiked this summer because it seemed that other countries were going to suffer worse recessions than the United States. But the dollar loses value when interest rates are low, and the Federal Reserve's decision to drop rates to near-zero certainly didn't help the greenback. The Fed isn't likely to raise interest rates to help the dollar because that would harm the economic recovery.

If you agree with Seiver -- that the dollar's trajectory is downward -- you can play the decline by buying a mutual fund that does just that, such as the ProFunds Falling U.S. Dollar (FDPIX), which rises every time the dollar drops.

Another path is to buy companies that have large overseas sales. Hickey said those sectors tend to be technology, industrial materials, energy and consumer staples. If the dollar remains weak, it's going to make other countries' imported goods and services more expensive and U.S. exported goods and services cheaper. The United States has a large trade deficit and imports more than it exports. That means it sends a lot of its capital abroad. With a weaker dollar, U.S. exports will rise and help domestic producers of those goods and services.

"It should be easier for them to undercut the foreign competition because the foreign competition had to fight against the falling dollar," Seiver said.

Another option is to invest in foreign stocks that are denominated in foreign currencies. Try an international index fund that does not include the United States. "If the dollar falls, the share values of those companies in dollars will go higher," Seiver said.

With any of these strategies, don't forget to do your due diligence and make sure you're investing in sound companies, the strategists said.

"Any particular company can say they earn 7 percent overseas, but what if they are poorly managed or make a bad product," Seiver said. "You've got to be careful."