One Good Idea: Buy Japanese yen

The currency appears poised to soar over the next few months as stock markets languish

By Dianne Maley
Globe Investor Magazine Online, February 23, 2009


The Idea: Buy the Japanese yen.

The Source: David Rodriguez, quantitative analyst at DailyFX.com.

Over the past 12 months, the yen has soared 42 per cent against the New Zealand dollar, 35 per cent against Australian dollar, 30 per cent against Canadian dollar and 15 per cent against U.S. dollar.

"Its strength so far has been nothing short of amazing," Mr. Rodriguez said.

The yen has surged in response to the unwinding of the so-called yen carry trade, in which investors borrowed at low interest rates in yen and used the loans to buy higher-yielding assets in other currencies. Now those same investors are selling their foreign currency holdings in order to repay the yen-based loans.

Given the stellar performance of the Japanese currency, one might wonder whether it has much further to go. Mr. Rodriguez thinks it does.

Analysts at DailyFX figure the yen could rise another 12 per cent against the U.S. dollar. While the short-term outlook is "extremely uncertain" - a stock market rally could undercut the yen's strength - medium term, it still has a way to go, he figures.

"If you're trading a few months out, it's a more straightforward proposition," Mr. Rodriguez says. "The yen still represents a fairly good play as far as buying against major currencies."

Currency trading used to be the preserve of a bold and savvy few who had money to burn and loved the thrill of speculating in such a vast and fast-moving market. But currency dealers such as Forex Capital Markets in New York, DailyFX's parent, and Friedberg Direct in Toronto have lowered the stakes, allowing retail investors to open "micro" trading accounts with just a few hundred dollars and devising strategies to limit their risks.

The allure of direct currency trading is the potential leverage - up to 200 to one, Mr. Rodriguez notes. Traders put down a small amount of money and borrow the rest. That also means unlucky investors can lose their entire stake in no time at all. A more conservative way to buy the yen is through an exchange traded fund listed on the New York Stock Exchange, the Currency Shares Japanese Yen Trust (FXY), sponsored by Rydex Investments and designed to track movements in the yen. The ETF does not use leverage.

The Payoff: If the analysts at DailyFX are right and the yen has another 12 per cent or more to go against the U.S. dollar, investors in Currency Shares Japanese Yen Trust would end up with a respectable gain from an investment that tends to move in the opposite direction to stock markets. Currency traders who buy the yen against, say, the euro, could do even better because the euro is still weakening against both the yen and the U.S. dollar.

The Big Risk: Stock markets could rebound, which could tempt people to start selling the yen short again to buy stocks, bidding up other currencies against the Japanese currency.

Why listen to David Rodriguez? Six months ago, Mr. Rodriguez recommended buying the yen against the euro when the euro was worth 1.60 yen. The euro recently bought only 1.19 yen, a 25 per cent gain for the yen.

Special to the Globe and Mail