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A Profit Trifecta… How this Unsung Currency Play Lets You Profit Three Ways

Sean Hyman (July 9, 2009)

Thursday, July 9, 2009

Sean HymanAs many of you know, I’ve been trading currencies in the Forex market for years. I’ve made a career out of pairing the euro with the dollar, the Japanese yen with the euro, and the Swiss franc with the euro…among other currency pairs.

But even though I’m a traditional Forex trader and I’m constantly checking the bid and ask prices for my favorite currency pairs, I’m still always looking for other currency opportunities around the globe…even the more obscure, “unsung” currency plays.

Take foreign bonds for instance. Investors, even American investors have been able to buy foreign bonds for decades. Yet, few foreign bond investors really think of themselves as “currency investors.” The reason? They don’t realize a foreign bond is also a “currency play” too.

“Trading Currencies” Involves So
Much More Than Just Forex

The irony of all this? Foreign bonds are actually one of the most intriguing currency plays in the market today.

If you choose the right one, you can actually profit in three different ways…from capital gains (assuming you buy a bond below par), yield, and currency appreciation if the dollar drops against the currency your bond is denominated in.

In that way, this “unsung” currency play is actually a profit trifecta…if you can choose the right one. Let me explain…

Why the Currency Matters…

When you are investing in a foreign bond, you not only need to have an opinion about what that bond will do but also an opinion about how that country’s currency will fare against your own. That’s where the currency play kicks in.

For instance, if a foreign bond earned 8% interest…that sounds great, right? However, what if I told you, while you were invested in the bond, your currency strengthened 10% against that foreign bond’s currency? Then is it such a good idea?

Gain 8% but lose 10% when you go to convert the money back into your home currency…hmmmm, doesn’t sound like such a good deal to me.

However, what if I told you that a foreign bond earned 5% but your home currency weakened against the foreign bond’s currency by 7%? Now, by the time you take your 5% gains and convert them back into your home currency, you end up with 12% more money than you had before! Now, we’re talking!

Turbo Charge Your Returns by Picking the Strongest Country FIRST!

So when you’re looking to buy a foreign bond, the yield or potential capital gains your bond can earn are just part of the equation.

The other vital part is what happens to the dollar and your bond’s foreign currency from the time you buy your foreign bond and its maturity date. Depending on the currency, it can either hurt your overall returns, or it can turbo-charge your returns.

Choose a Strong Currency First, That
Looks to Beat the Dollar

Therefore, the way I’d play foreign bonds is to FIRST get an opinion on the foreign currency and how you think it will perform vs. your home currency.

Then if you believe the foreign currency will trounce your home currency for the period of the investment, then look into their bonds. That way, if you’re right about the foreign currency’s direction vs. your home currency, you stand a much better chance of making a really nice return on your money (over and above the actual interest earned on the bond itself).

(Also, note that if you hold a bond until maturity, then you don’t have to worry about the bond’s price and you can just focus on the bond’s yield that it gives you over time.)

Your Bond Checklist: 3 Things Your Bonds Need

So the next question is, “How do you know what country could be good to invest in?”

When looking at a bond, you want the highest yield for the least amount of risk. Some of this you can gauge by S&P and Moody’s outlook in how they rate a specific country’s bonds. I’d suggest investing in “investment grade” bonds for your first bond investments.

Government bonds can be a great place to start, for instance. In this case, if you can ascertain whether the country is in good enough shape to make good on its bond payments, then you can ascertain the risk that you’re taking on.

Personally, I look for countries that have some of the highest GDP growth out there and have the least amount of debt proportionately. Here’s my checklist. I look for bonds from countries with…

  1. High growth possibilities
  2. Doesn’t have a mountain of debt
  3. Has a favorable rating from S&P or Moodys

By the way, this is why foreigners are questioning U.S. Treasuries. We have a mountain of debt and sluggish growth (in fact, negative growth at the moment)! So I can’t blame them for being concerned about our bonds after I just told you how I’d judge a country’s bonds.

Stretch your Retirement Dollars & Outpace your Country’s Inflation!

Just to recap, get an opinion on the overall state of your own country’s economy vs. the economy of the foreign currency. See which currency has the best sentiment and fundamentals going for it.

Find a country that is hitting on all cylinders and looks to outperform your country and your native currency. Then find that country’s investment grade bonds (preferably their government backed treasuries at first).

Then if you’re right on the direction of the currency, you’ll get a great “bonus” in addition to the interest. In doing the proper analysis, it can really help your money to beat inflation.

This can be a great way to stretch your retirement dollars or to simply “outpace” the inflation coming for your home country!

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