Betting against the US dollar has been a bad idea. The US Dollar Index’s 16-year bull run reinforces the power of the Greenback as the world’s reserve currency.
Nothing, however, rises forever. With US interest rates expected to be cut three times this year based on US Fed data, the odds favour a gradually weakening US dollar this year and next.
To be clear, I don’t expect a significant fall in the US Dollar Index, which measures the Greenback’s value against other widely traded currencies. Rather, that lower US interest rates will be accompanied by a US dollar that edges lower as institutional investors reallocate capital to countries with higher rates and yield.
A lower US dollar has many investment implications. It typically aids commodities, gold, emerging markets, and US companies with a higher proportion of export sales.
Currencies, of course, are notoriously hard to forecast. Moreover, buying an asset based on currency forecasts is fraught with danger. Gold bullion, for example, is affected by factors such as central bank buying. Emerging market equities, too, are affected by a range of factors beyond the Greenback.
That said, Australian investors, particularly those with international assets, should consider the implications of a gradually weaker US dollar in the next few years. With the US ahead of Australia in expected rate cuts, a slightly firmer Australian dollar against the Greenback is likely.
Portfolio hedging is another important consideration. When the Australian dollar strengthens, the value of unhedged global investments declines in Australian dollar terms, compared to the equivalent hedged exposure. Increasing exposure to currency-hedged offshore assets, such as hedged international ETFs, makes sense for those like me who believe the Australian dollar will slowly appreciate this year.
For this column, my interest is in a weakening US dollar and ways to play that trend. Here are three ideas that stand out at current valuations:
1. Emerging market bonds
Emerging market (EM) equities historically do better when the US dollar weakens, and vice versa. EM equities can badly underperform when the Greenback rises.
A stronger Greenback makes life hard for emerging markets in two main ways. First, many developing countries borrow debt in US dollars. When the US dollar is stronger, repaying debt becomes more expensive. A strong US dollar, and higher borrowing costs, have long been a source of financial crises in emerging markets.
Second, when US interest rates are higher, capital moves back towards the US in search of higher returns, and away from emerging market economies, which often rely heavily on foreign capital flows to fund their fiscal deficits.
All things being equal, a weakening US dollar should support emerging markets in the next 18 months. But in my experience, retail investors rarely consider emerging market bonds. Most fixed income Exchange Traded Funds (ETFs) on ASX are over bonds in developed rather than emerging markets. If they have exposure to emerging markets, it is usually through equities.
Emerging market bonds have performed surprisingly well, producing positive returns in 17 of the last 20 years. As developed markets run ever-larger budget deficits, many emerging markets are now running surpluses.
The VanEck Emerging Income Opportunities Active ETF (Managed Fund) (ASX: EBND), is one of few ways to gain emerging-market bond exposure, through an ETF structure. Bought and sold like a share, EBND holds 108 securities, across a large number of countries in the Global South.
EBND has returned 8.6% over one year to end-March 2024, most of it from income rather than price growth. Over three years, EBND’s average annualised return is only 2.88%. As the US dollar gradually weakens, emerging market equities and particularly emerging bonds could start to lift their return. EBND’s management fee is 0.95%
Chart 1: VanEck Emerging Income Opportunities Active ETF (Managed Fund)
Source: Market Index
2. Gold equities
In October 2023 for this column, I highlighted the growing disconnect between physical gold and gold equities. I noted that gold equities had significantly underperformed physical gold because of cost blowouts, production issues and the sector’s record of overpaying for acquisitions.
I wrote at the time: “If I’m right and gold edges higher in the next six months, gold equities will look a lot more interesting.” I got the direction right but underestimated the extent of the rally in physical gold. The view to look closer at gold equities, some of which have rallied sharply this year, was timely.
I suggested the BetaShares Global Gold Miners ETF – Currency Hedged (MNRS) ETF as a simple tool for exposure to gold equities.
MNRS tracks an index that comprises the world’s largest gold-mining companies (excluding those in Australia) and is hedged for currency movements.
The index comprises 44 gold companies, mostly in Canada and, to a lesser extent, the US. Key holdings include Franco-Nevada Corp, Newmont Mining Corp (which has acquired Newcrest Mining in Australia), and Barrick Gold Corp.
I said at the time: “After three years of poor performance, MNRS should do better in the next 12 months as US rates and the US dollar peak, and gold bullion improves.” That view holds.
MNRS has spiked higher this year but remains well down on prices achieved in late 2020, despite gold bullion trading a record higher. After underperforming gold bullion since 2011, global gold equities could have further to run this year. Lower US rates and US dollar weakness are typically good for gold and, by default, gold producers, some of which are showing more discipline on acquisitions and should benefit from easing cost pressures.
For now, I prefer currency-hedged ETFs, making MNRS a better choice over unhedged ETFs that provide exposure to gold equities. MNRS’s fee is 0.47%
Chart 2: BetaShares Global Gold Miners ETF – Currency Hedged (MNRS)
3, US exporters
US companies that derive a higher proportion of revenue from export sales should benefit from a gradually weaker US dollar. This relationship is not always as clearcut given the complexities of multinational corporations that have multiple currency exposures. But backing high-quality US companies that rely heavily on exports has more appeal as the Greenback weakens.
The new BetaShares Global Cash Flow Kings ETF (ASX: CFLO) is an interesting idea in this regard. Although CFLO is not especially about exporting, around 74% of the ETF’s 200 constituents come from the US. They include a range of companies that export goods, from technology to consumer products and food.
I’ll do more work on CFLO in coming months. Suffice it to say, backing companies with strong free cash flow and low debt is a good idea at the best of times. A weaker US dollar could give that cash flow a boost from export sales.
Launched in November 2023, CFLO is off to a good start, returning almost 11% over the last three months to end-February 2024. The management fee is 0.40%.
Chart 3: BetaShares Global Cash Flow Kings ETF
Source: Market Index
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation, or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation, and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 10 April 2024.
