Dec 172013
 

There’s a common misconception that cash is somehow a safe asset. People who have lost money investing in the financial markets may believe stocks are risky, and cash is safe. But what if I told you that not all cash is created equal 8-)

Iceland was hit even harder by the 2008 financial crisis than the U.S. and it’s 3 major banks went bankrupt. Global investors slowly lost confidence in Iceland’s economy and therefore, the value of its currency was called into question. Before the credit crisis each Icelandic Krona was valued at roughly 1.5 cents U.S. But after 2008, the Krona was only worth 0.75 cents U.S.  This effectively cuts the purchasing power of the Krona, and anyone who had it, by 50%. Imagine if you lost half your savings :( So much for cash being a safe haven :?  13-12-kronacurrency

Hungary’s currency lost almost its entire value after WWII. And even Germany, the economic engine that’s driving Europe today, once experienced a currency devaluation itself in the 1920s and was forced to create a brand new currency because it’s old German Marks had literally become worthless. No country, regardless of its global reputation today, is immune to currency risk. Smart investors know this ;) So if cash isn’t risk free, what can we do? The answer is simple. We all know diversification reduces risk. We diversify stocks by buying different companies. So similarly we can diversify “cash” by investing in foreign currencies (^_-)

The equivalent of $4 trillion USD is traded in the foreign exchange market everyday, which is much more than the global stock or bond markets. Currency hedging is already an important investment strategy for many rich households, and ordinary people like you or I can take advantage of it as well :D Today’s post explains how.

Much like individual companies in the stock market, each currency in the world has its own value. This means that similar to stocks, it’s possible for currencies to be undervalued or overvalued.

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Over the last year the Canadian Dollar has dropped in value relative to the Singapore Dollar (SGD). This is because Singapore’s economy is growing faster. It has a lower unemployment rate (only 2%!) and it’s running a trade surplus. Canada is still running a trade deficit which means if our economy was a business then we’re spending more than we’re making because we’re importing more than we’re exporting. If you bought SGD a year ago using CAD then you would be about 5% richer today if you sell your SGD back for CAD now :)

Famous investor Jim Rogers says he’s bullish on the Russian Ruble, the Chinese RenMinBi (Yuan) and other Asian country currencies. I don’t share his sentiment on the Ruble because I’ve heard horror stories about investing in Russia. But I do see good opportunities in Asia, and even in Australia/New Zealand, with relatively high GDP growth, and stable policies.

So which currencies do we invest in? The answer depends on each individual’s situation. But personally I’d like to hold some U.S. dollars, as well as currencies in countries with a strong economy and a trade surplus. Luckily, I’m already well exposed to the U.S. Dollar. I currently have about $45,000 USD in my margin account, which has proven to be a fruitful investment as the USD has appreciated against the Loonie by 6% over the past year \(^_^)/

As for a foreign currency with an underlying strong economy. I’ve decided to go with China’s currency, the RenMinBi. Right now the value of the RMB is artificially suppressed by the central bank. But at the end of the day it’s all about supply and demand. Despite the Chinese government’s efforts to keep the Yuan from appreciating, increasing demand has boosted its value tremendously versus the U.S. dollar over time.

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The way to build a successful society is with capital. China’s personal savings rate is over 30%, which is a lot of capital that can be used for investments. Americans on the other hand save less than 5%. China also buys a lot of U.S. debt, which the U.S. tax payers have to pay interest on, which then makes the Chinese even richer, benefiting the Chinese economy (and currency) even more.

We can treat currencies like we do stocks. Find the undervalued buys that have long-term growth potential (^_^) If China was a publicly traded company, it would probably be a very popular stock. That’s why demand for the Yuan is increasing, hence the graph above. A few years ago China overtook Japan as the world’s 2nd largest economy. Many predict it will eventually surpass the U.S. to become number 1. I have been missing out on the Yuan’s appreciation for far too long :evil: It’s time I took action! So last week I went to my local currency exchange dealer and purchased ¥5,000 :) (photo below)13-12-5kyuan

I bought the 5,000 Yuan for $0.18 CAD each. I basically traded $900 Canadian Dollars for ¥5,000 Chinese Yuan, including commission. The market price was actually $0.175 CAD (or $1 to ¥5.72) Will the Yuan continue to grow over time and make me rich, or was this a big mistake? I don’t know yet, but I’ll keep you readers posted (^o^)丿
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Investing in foreign currencies can be a very useful ­diversification tool, especially for portfolios that are heavily weighted to the domestic market. What I explained today was how to buy and hold foreign currency for the long term appreciation potential, which is different than opening up a Forex Trading account and using leverage to invest/speculate. Forex trading is a related, but different topic which I’ll cover in another post.
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  9 Responses to “Investing in Foreign Currencies”

  1. You bought physical Yuans? Why not online forex? I always think about adding it in my forex account but it would be a long term move and generally I trade short term.
    I am long GBP short JPY, long EUR and long gold too at the moment. Trying to make a bit so when I move currencies around my accounts it ends up being free.

  2. Something I’ve never tried, but a very interesting read!

    • I know right :D The Yuan is now the 2nd most used currency for trade finance in the entire world. Even if the USD remains the best international currency in the future, it’s probably still good to keep our trade options open.

  3. I have $200 USD laying around leftover from my trip but I usually like to spend my cash on hand!

  4. […] year I wrote a post about how to invest in foreign currencies and how I personally bought a lot of U.S. dollars and Chinese Yuan. Luckily those decisions are […]

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