As ETFs become more ingrained into the financial sphere, investors and managers are becoming more creative about how to deploy their capital. Recently, in London, Commodity ETFs were released, allowing an investor to purchase futures contracts in a particular commodity as if it were nothing more than a stock.
While these securities are not yet trade-able, that will change in a few weeks time. One of the more interesting ETFs to be unveiled recently is the DBV currency fund. This fund goes long high yielding currencies while going short some of the world's lowest yielding currencies. While this strategy is provocative considering the fund is certainly a pioneer in this area, we believe it is likely one of those ETFs that is destined to perform poorly over the long run.
Major currency moves often time happen in direct opposition to their current yields. Therefore, the assumption that a currency will appreciate once its yield is high, confuses the cause and effect relationship of fiat money. Rather, the movement of the currency is often what dictates the direction of interest rates.
Back in May of 2006, the developed world's highest interest rates belonged to New Zealand and Iceland. With rates in those countries 2-3 times what they were in the US and the rest of Europe, those currencies were, without a doubt, the highest yielding currencies available to the traditional forex investor. In just a few short weeks time, both currencies collapsed, sending the Krona and the Kiwi spiraling down for weeks. Had the DBV fund been around during May, it would undoubtedly have gotten crushed using the strategy they are currently pursuing.
In response to the depreciation of their currencies, the New Zealand and Icelandic central banks raised interest rates by hundred of basis of points each in an effort to stem the outflow of money. While admittedly this is only one example, we believe this is sufficient to show how the movement of a currency often is what dictates interest rates, as opposed to the other way around.
The DBV fund, which bets on currency appreciation for those countries with high rates, confuses the cause and effect relationship between the value of money and the available rate of interest. In addition, the fund completely ignores any political and economic changes happening in the countries involved. Japan, which has had the lowest interest rates in the world for the past decade, looks to have finally beaten deflation, and is ending is zero-interest rate policy (ZIRP). While the DBV is unquestionably short the Japanese Yen, we here are the Commodity Investor believe the Yen is likely to be one of the better performing assets over the next few years.
This is a classic example of technical (DBV) versus fundamental (The Commodity Investor) analysis. History has generally proven the fundamentalists correct most of the time. This time is unlikely to be any different.
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