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The Beauty of Currencies

In the currency market, you can design a portfolio that has low correlation to your other assets, says Axel Merk, President, CIO, and portfolio manager of Merk Mutual Funds.

Morningstar, 04/03/2012

This article originally appeared in the April/May 2012 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.

1. Odds that the eurozone breaks up.
Not likely, but the politics can take on a life on their own.

2. Was the concept of creating a European common currency flawed from the start?
The one flaw was that policymakers tried to have the spreads in the eurozone be as low as possible. But as long as the peripheral countries pay more for their debt, it is perfectly compatible to have them all in a currency unit.

3. Explain how your view of the euro has evolved.
When the euro was rushing toward 118, we said, “Buy the euro. The issues of the eurozone shall be expressed in the spreads of the bond market.” And, indeed, that has happened. What we liked about the euro until not too long ago was that the market was in charge. Whenever the market imposed austerity, those were implemented. Now, with the help that has been given by the central banks, we are far more cautious because the pressure to reform is gone.

4. How are the developments in Europe affecting other currency markets?
The World Bank expressed it best: Hope for the best, but plan for the worst. In central-banking speak, that means print money. What that means is that you want to be where they are not printing as much money, where you have the greatest monetary sensitivity.

5. Where is that?
The New Zealand dollar. It’s a commodity currency. They are ramping up their rebuilding effort after last year’s earthquake. As a result, the economy may be heating up, and the central bank may need to tighten further.

6. Why invest in currencies?
Diversification. In the currency market, you can design a portfolio that has a low correlation to your other assets. 

7. But can an investor earn a decent return investing in cash?
The question is, What is decent? On a risk-adjusted basis, currencies can offer fabulous returns. But you are not going to invest in the currency markets if you’re interested in 20% returns.

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