JULY 17, 2012 INTERVIEW TRANSCRIPT PART 1: WHY WORRY ABOUT CURRENCY TRENDS? HERE’S WHY

The following is part 1 of an interview I gave on http://www.moneyradio1510.com on the program Hey Jim with one of Phoenix’s top CFPs, Jim Graham, on Basic FAQS For US Investors Regarding What All Investors Need To Know About Currency Markets

Cliff, your focus is on Currency investing.  A lot of our listeners are well diversified with their portfolios.  They have international investments.  Why should they be concerned about currency fluctuations?

Cliff:

Well, Jim, there are a number of aspects to that question. Let’s split it into 2 parts:

PART 1: HAVING INTERNATIONAL INVESTMENTS DOESN’T MEAN YOU’VE HEDGED CURRENCY RISK, AND DEFINING CURRENCY RISK AND HOW WE PROTECT OURSELVES FROM IT

Most international investment advice focuses on the prospects of the specific stock or asset, but typically neglects to consider the long term health of the currency to which it’s tied.

For example:

1. A Spanish telecom might be doing well, but if there’s real risk that the EUR is going to plunge, or that Spain might revert to a local currency worth much less, then depending on exactly how things play out, that investment’s real return after adjusting for loss of value of the currency in which its valued, and pays dividends, is going to suffer dramatically vs. the USD.

2. Similarly, Australia’s economy is intimately tied to china’s. an otherwise solid Australian investment could become a loser as china’s slowdown continues, as many believe it’s likely to do and indeed is doing so already, because the AUD would decline vs. the USD and so the value of any Australian stock and its dividend would also fall for a US investor.

These 2 examples illustrate how it’s not enough to just have international investments in good businesses, even if they pay a good, safe dividend. You have to at least consider the long term health of the currency to which it’s tied, at least for the period in which you plan to hold the investment. You could own great Spanish, Italian, Japanese, or Australian investments but see your gains reduced or wiped out in USD terms if the EUR and AUD continue to fall vs. the USD.

In sum, just because you have international exposure doesn’t mean you’ve hedged currency risk. When building a portfolio, prudent planning demands that it not only be diversified by currency, but by the right currencies that have the best long term prospects of holding their value and appreciating vs. the other major currencies. Otherwise you could easily wind up exchanging USD exposure for a worse currency

Also, most ‘internationally diversified’ portfolios don’t provide real currency diversification because:

— their international exposure consists of shares in US multi-nationals which provide only indirect exposure, may not be tied to the right currencies in the right proportions, and probably pay USD -denominated dividends

— Their international exposure may be via shares in foreign companies which are too heavily exposed to the USD

— Many overseas stocks and bonds bought in the US and elsewhere are still either denominated in USD or pay dividends in USD

PART 2: WHY EVEN BOTHER WORRYING ABOUT CURRENCY FLUCTUATIONS? WHY NEED CURRENCY DIVERSIFICATION IN YOUR PORTFOLIO AND PASSIVE INCOME STREAM

A: Obviously, you’re exposed to currency risk- the silent, deadly tax of loss of purchasing power – even if you earn and spend only in one currency – contrary to what many think.

For example, if any of the major currencies just mentioned appreciate vs. the USD, then USD based investors lose purchasing power for any goods or services connected to the EU, Australia, or China – INCLUDING US made goods using inputs from those countries or those connected to them. A lot of products you buy are either made in those places or use inputs from them.

Just because you earn and spend in USD doesn’t mean you’re insulated from the dollar’s fluctuations.  You’re not, because the price of imported goods is built into so much of what you buy. that’s a problem because the USD had been in a steady decline for decades vs. most of the world’s major currencies.

For example:

  • Since 2000 down over 30% vs. the CAD
  • Since 1990 down over 50% vs. the JPY
  • Since 1970, down ~ 75% vs. the CHF
  • In 1971 the USD bought ~3.65 dm. that is, the dm was worth ~$0.27 in 1999, just before the dm was replaced with the EUR, the dm was worth ~$0.50. Before the EU debt crisis the euro, a rough equivalent of the DM, was worth as much as $1.6 — over 5x as much since 1971. (http://www.history.ucsb.edu/faculty/marcuse/projects/currency.htm )
  • Remember the series of travel books that began as Europe on $5/day ended in 1998 as Europe on $50 day or more.
  • Remember when reliable Japanese cars were considered inexpensive?

As the USD has fallen over price increases of many imported goods (like oil, machine parts, rare earth metals, etc) has rippled through the economy and is one of the reasons we’ve seen us disposable incomes shrink.

In short, though most Americans earn and spend in USD, that doesn’t mean their insulated from the costs of a declining USD.

That decline is likely to continue over the long term as demand for the USD continues to fall, partly due to the US debasing the value of its own currency as a store of wealth via various stimulus plans and debt expansion, partly due to other rising nations seeking to weaken US influence

This decline has come into focus more since 2007 as USD’s reliability as a store of value has been undermined by the Fed’s assorted stimulus policies and low rates. Major export nations and sovereign wealth funds that hold hundreds of billions of US dollars in their foreign currency reserves have realized that the USD is no longer a reliable store of value. Like any prudent investor holding an asset that’s in a downtrend, they’ve began to diversify out of the USD.

For example:

  • In 2011, Russia and China, began to move away from the US dollar and have been using rubles and renminbi to trade with each other since. In early 2012, the second-largest economy on earth – China – and the third-largest economy on the planet – Japan – also reached a deal to increase the use of their own currencies when trading with each other. The deal enables their businesses to directly convert Chinese and Japanese currencies, instead of using US dollars as the intermediary as has been the requirement for years.
  • China is working on similar deals with both South Korea and Malaysia, as with well as various nations in Africa, so are the BRICS nations (Brazil, Russia, India, China, and South Africa), and so are Russia and Iran. All seek to use of their national currencies when trading with each other, instead of using the US dollar.

See here for further details

With Fed policy continuing to favor economic stimulus (of questionable effectiveness) over preservation of the USD’s value, it’s reasonable to expect continued erosion of USD demand as the world prudently reduces its holdings in favor of currencies backed by responsible governments that offer safer stores of value. The lesson for those based in US dollars is clear. We too need to diversify our currency exposure.

As with any asset, long term decreasing demand suggests deceasing price. The USD’s recent strength is mostly a function of the problems in Europe and the weakness of the EURO, which for technical reasons tends to push the USD in the opposite direction and give it strength unconnected to its underlying fundamental weakness.

So how do you prevent this loss of purchasing power? By learning how to read long term currency trends and to identify which currencies have the best long term up trends, backed by strong fundamentals. Ideally, most or all of your international investments will be tied to or at least heavily exposed to them. I cover this in my new book, The Sensible Guide To Forex, the only collection of solutions for achieving prudent currency diversification for risk averse mainstream investors or traders.

POINTS TO REMEMBER:

  1. A declining dollar drags down the value of most assets denominated in it, including your portfolio and thus your purchasing power and real net worth. That’s why any prudent investment planning needs to consider currency diversification.
  2. Even relatively sophisticated investors tend to have virtually all their assets denominated in their local currency.
  3. Failure to hedge currency risk is arguably the most common and least known investor mistake
  4. you need diversify fx exposure just like you diversify by sector and asset class
  5. can do that either as active trader or passive income oriented investor with no interest in trading
  6. The problem is that practical solutions have been hard to find. The typical forex trading is too risky and demanding for most investors, and offers little for income-oriented investors. There are safer, simpler ways to get that exposure, either as an active trader or passive income investors, but no one has gathered them together in one source.
  7. Most investors remain fairly ignorant about hedging currency risk due to a combination of a few factors:
    1. retail forex is relatively new, only about 10 years old, therefore both the public and media are woefully ignorant about forex markets and how mainstream investors can exploit them
    2. most forex brokers and writers are focused on high risk styles of trading at which ~ 70% of traders fail within a matter of months due to lack of proper training or inability to find a method that suits their personality and skill level. the retail forex industry itself has not yet made it easy for mainstream investors to find simple, safe ways to invest or trade.
  1. As the Chief Analyst for a number of forex firms I’ve seen how hard it is for retail investors to find ways to attain this needed currency diversification, and spent years gathering the kind of safer, simpler ways to get that diversification, either as an active trader or passive income investor seeking a higher yielding, safer income stream.
  1. They’re all in my new book, The Sensible Guide To Forex; Safer, Smarter Ways To Prosper From The Start, coming out this September but already available for advanced order.  See here for a full description of the book, and here for advanced reviews.
  1. The companion website, www.thesensibleguidetoforex.com, will have supplementary bonus material and an ongoing stream of articles on market analysis, investing and trading ideas, and training. One of the firms i work with will also have an entire training course using the book as the text.

Stay tuned for publication of the rest of the interview over the coming weeks.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE WERE SURE WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE? 

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