Monday, March 31, 2008 0 comments ++[ CLICK TO COMMENT ]++

Worth Increasing US$ and Yen Exposure

Over the last year I have been wrong--big time--regarding the US$. I paid for my incorrect decision by losing around 10% of my portfolio last year due to the US$ decline against the Canadian dollar. However, I am maintaining my mildly bullish view of the US$. The US$ will likely fall while its economy weakenes and the Federal Reserve cuts rates, but I believe it has declined sufficiently against the Canadian dollar. My feeling is that the US$ will mostly fall against the strong Asian currencies and the Yen.

I am also strongly bullish on the Japanese Yen. The Yen has increased quite a bit in the last few months but I believe it has further to go (but this can take years). I am planning to increase my exposure to the US$ and Yen. Ideally, I would like to hold 50% of my portfolio in Yen-denominated assets (such as Japanese stocks). The Japanese stock market has been selling off like crazy so I'm not sure if I should just convert some money to Yen and wait, or to plunge headfirst while the sell-off continues.

The chart below from Yahoo Finance shows the relationships between the US$, C$, and Yen (note that this is not the same as the US$ index, which is against a basket of currencies).

I annotated the chart with my observations (hope they are not too distracting). To sum up, The US$ and Yen have been coupled together for the last 7 years or so. This is likely due to Japanese government intervention to keep the Yen cheap against the US$ (Japan exports a lot to the US). In the last few months, the US$ has plunged against the Yen (resulting in the unwinding of the Yen carry-trade) but I am not sure if that will continue. It is possible that the US$ may couple with the Yen and strengthen if there is capital flight to US$-denominated assets (typically happens during crises in the developing world, as was the case in 1997). The sell-off in gold lends some credence to the view that the US$ may strengthen. In any case, from my point of view as a Canadian, the C$ has been trading flat against the US$ lately. I think the run-up in the Canadian dollar (mostly due to commodities) is over. I think any risk of US$ weakness relative to the C$ for Canadians is minimal now. This, of course, doesn't mean that the US$ won't fall against, say, the renminbi.

The Canadian dollar, as a quasi-commodity curency, has strengthened significantly against the US$ and Yen in the last 7 years. The question for me is whether it will weaken against either of them in the future. It is possible that it will be flat against the US$, while weakening against the Yen.

Currencies are not my game and I wouldn't make an investment based solely on some vague feelings of where a currency should be. However, I think I can tailor foreign currencies and use them as a diversification tool. I plan on increasing my Yen-denominated investments (basicaly Japanese stocks). What I have suggested is mostly a contrarian view, given that the consensus is for much further weakening of the US$, not to mention bullishness for the Canadian dollar.

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