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How To Make Big Profits From This Falling Currency

 January 02, 2013 06:26 PM


One mark of a successful investor is the ability to think outside the box.

There is a never-ending opportunity for investors who remain open to new horizons. Many investors get trapped with a myopic view of the possibilities -- some only invest in stocks, while others are fearful of stepping outside of the United States in search of profitable investments.

Still, others have an irrational fear of certain investments such as commodities or currencies, falsely believing only the most sophisticated and well-heeled investors can understand these markets. Well, the truth is today's financial markets are globally interconnected, making it sometimes necessary to step outside of your comfort zone to find compelling investment opportunities.

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With this edict in mind, I asked myself, ''What is the most overriding theme in the global economy right now?"

The answer is monetary easing by central banks worldwide. This tactic of pumping currency into an economy in an effort to jump-start growth has become very popular. Monetary easing weakens the currency and can often supercharge markets due to low interest rates and improved borrowing conditions.

And nowhere is monetary easing more aggressively used than Japan.

Right now, the Japanese government has imposed heavy monetary easing measures that are dramatically weakening the yen. In fact, newly-elected Prime Minister Shinzo Abe has demanded the Bank of Japan engage in unlimited printing of the currency.

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In addition, Japan appears bent on lowering interest rates, even if this means dropping them to below-zero levels. The reason for this drastic action is because domestic consumption is dropping in Japan. This means exporting needs to be ramped up to support the economy. And the primary way to improve exports is by devaluing the currency. As you can see from the yen chart below, actions by the Japanese Central Bank spurred by the prime minister's words have resulted in a steep decline in the currency.

Currency traders are making a killing shorting the yen right now. In fact, there is no end in sight for the monetary easing measures in that country. This means the yen is very likely to continue to fall for the foreseeable future.

While stock investors can open a forex account to ride the accelerating yen downtrend, exchange-traded funds (ETFs) allow you to benefit directly from the falling currency within an existing stock investment account.

There are two primary ETFs investors can use to capture profit from the yen's decline -- CurrencyShares Japanese Yen Trust (NYSE: FXY) and ProShares Ultra Short Yen (NYSE: YCS). The one you choose as your weapon of choice depends on your holding period and goals.

ProShares Ultra Short Yen ETF is a double leveraged inverse ETF, which means that every tick in the yen is reflected as a two-tick move in the ETF. But due to the rebalancing required to maintain the double short leverage, this ETF is designed to inversely follow the intraday move of the yen, not long-term. This means if you are an active trader who can closely watch the ETF and perhaps even close it out at the end of every trading day, then this ETF would provide you with the most bang for your buck, though it is not designed as a long-term investment.

The CurrencyShares Japanese Yen Trust is a plain vanilla ETF designed to follow the yen without any extra leverage. However, unlike the YCS, it's important to short this ETF to benefit from the falling yen. It can be held short for the long-term without any adverse effects, as there is no constant rebalancing of the underlying instruments to maintain leverage.

Risks to Consider: While it seems like a slam dunk that Japan will continue to take action to weaken the yen, anything can happen. Even a hint that Prime Minister Abe is changing his position will cause a sharp upward move in the currency. Investors who are caught short the yen through ETFs or the currency itself could suffer sharp losses in this event.

Action to Take --> I expect the yen to continue its downward trend well into 2013. Therefore, both of these ETFs are great investments right now. As an active short-term trader, I would lean toward the ProShares UltraShort Yen ETF for the benefits of the leverage. However, if I were more of long-term investor, then my ETF of choice would be a short position in the CurrencyShares Japanese Yen Trust. Remember to always use stops and position size based on your risk tolerance when investing.

-- Dave Goodboy

Dave Goodboy does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.
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