If 2011 taught us one thing, it’s that currency investing can be a dangerous business.
For instance, the euro – the simplest of hedges against a declining dollar and the U.S. Federal Reserve’s expansive monetary policy – has run into difficulties, losing billions for even the most sophisticated Wall Street banks.
But that’s not all. The Brazilian real, which was one of the best performing currencies of 2010, has dropped back sharply in 2011.
Still, if you harness the lessons of 2011, you can take advantage of the new opportunities set to emerge in 2012. In particular there are three currencies every investor should own.
I’ll get to those in a moment. But first, I’d like to fill you in on what currencies to avoid.
This is just as important – maybe even more so.
Currency Traps
Obviously, the euro is not to be trusted. If its problems were confined to Greece and Portugal, they would be surmountable.
But they’re not.
[ad#Google Adsense 336×280-IA]The extension of problems to Italy and Spain, which are both too large to bail out, makes the Eurozone liable to explode, split in two, or simply witness a mass default of several of its countries and much of its banking system.
Certain individual European shares may be a good buy. And German government bonds may be a good buy, since the German currency would explode upwards if the euro split.
But the euro itself? No thanks.
The Japanese yen isn’t safe either.
Unlike most other currencies, the yen has risen more than 50% against the U.S. dollar since 2007 and is up another 6% since the beginning of 2011. In short, it has done what President Obama would like China’s yuan to do.
Needless to say, Japanese exporters are suffering at these levels, and the country’s government debt, over 200% of gross domestic product (GDP) and all denominated in an appreciating yen, has become a serious worry. While the yen could rise further, it must be regarded as very unsafe.
The pound sterling is equally unsafe, but for different reasons.
The British government is running a budget deficit as large as that of the United States, while the British economy is highly dependent on the very unstable and overblown financial services sector.
The pound has some upward potential, and Britain’s balance of payments deficit is currently modest, but the Bank of England (BOE) has announced a $430 billion (275 billion pounds) “quantitative easing” program – equivalent to a $2 trillion program here in the United States. So if the United States gets in trouble, Britain is likely to be in even more trouble.
The Australian dollar and Swiss Franc both have safe haven potential, but both currencies ran up a long way in 2011 and the Swiss National bank is determined to print money in order to stop its rise against the euro.
Avoiding these currencies is the first step toward a profitable 2012. The second step is to load up on the currencies that will weather any potential economic downturn and soar should the global economy recover.
Three Must-Own Currencies
To that end, the three must-have currencies of 2012 are as follows:
- The Canadian Dollar (CAD): Canada is a close neighbor, but distinguished from the United States in having a sound banking system, a much smaller budget deficit, and huge energy and mineral wealth. The Canadian dollar had risen as high as $1.06 in the early part of 2011, but has since drifted back down to about 98 cents. At that level, it has further to rise and is an excellent hedge against any severe problems in the U.S. economy.
- The Chilean Peso (CLP): Like the Canadian dollar, the Chilean peso benefits from rising resource prices. Better still, Chile is by far the best-run country in Latin America, with a Transparency International Corruption Perceptions Index rating better than that of the United States. The next election is not until December 2013, so political stability is assured. The peso has fallen about 8% this year on fears about emerging markets, but Chile’s current account deficit is less than 1% of GDP. It has virtually no government debt and a large trust fund to cushion against shocks (such as last year’s earthquake, for example).
- The South Korean Won (KRW): The won is a hedge against problems in the United States, but also against a collapse in commodity prices. Contrary to the Japanese yen, the won has fallen about 20% against the dollar since 2007, and is flat on the year. However, even with high commodity prices, Korea runs a substantial current account surplus. It also runs a budget surplus with the lowest amount of government spending in the Organization of Economic Cooperation and Development (OECD) group of rich nations. So it is fabulously strong economically. The only potential weakness comes in the form of an election next April, but even the opposition in Korea is thoroughly pro-market and should cause few problems.
So there you have it. These are the three currencies investors must own in 2012. Stick with them and avoid the likes of the dollar, euro, yen, and pound. If you do, you’ll be set for a far more rewarding year in 2012.
— Martin Hutchinson
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Source: Money Morning