Wednesday, 8 February 2012

Taking advantage of extreme foreign exchange rates

As I write this post, the Australian dollar is back close to all time highs against the USD ($1.0804), it has reached 27 year highs against the GBP (0.6795) and is at all time highs against the Euro (0.8147).

I have previously posted that a good way to take advantage of this is to invest in undervalued foreign indexes / stocks when your home exchange rate is high so you get the double benefit of a recovery in the stock price and the benefit of downside protection due to an expected improvement in the currency (note that this protection is over the long term).

The problem I am currently facing is that stocks had their best start to the year in a decade in January in almost all markets. This means that the case for investing in those stock markets on their own merit is not as strong as it otherwise would have been. I have been looking at other products to see if the idea can be replicated. Interest rate products in the US / UK and Europe are not attractive to Australian investors currently as their low yields (1 - 3%) are far below what could be achieved by investing in Australian bank stocks (6 - 8%).

An alternative I looked into was also buying and holding foreign currency. The opportunity cost of this money however is the interest / dividend yield I could be earning while invested in other products. Options offer an attractive way to gain exposure at a lower cost however their costs tend to be very high and as they are OTC products making a small investment to 'test the waters' does not appear possible.

I am leaning towards putting my money into a German micro cap stock that I believe in as the stock is not affected by European woes (Chinese based company listed in Germany). The exchange rate for the Euro is outrageous and if the Eurozone was to come up with a solution for their current woes the currency would immediately snap back.

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