newjerseynewsroom.com

BY GERALD J. ROBINSON

NEWJERSEYNEWSROOM.COM

It’s headline news. The dollar has fallen to a 3-year low.

Indeed, so far this year the dollar has dropped 5.8 percent against the world’s major currencies, and there’s no end in sight.

One need not look far to find the reason: fear. The fear arises from the Fed’s hyper-loose monetary policy -- rock bottom interest rates and flooding the market with dollars -- linked with fiscal profligacy allowing out-of-control spending creating huge deficits and an upward spiraling national debt.

But the danger from the dollar’s fall isn’t immediate. In fact, it can be beneficial for corporations that derive a large share of their revenue from foreign sources. They can benefit in two ways from a weaker dollar. First, profits rise as the corporations convert their foreign denominated revenues into dollars. Second, their cheaper-dollar products become more price competitive in foreign markets, further increasing revenue.

This suggests that one promising avenue for investors to cope with the falling dollar is to invest in stocks of strong large-cap corporations that are heavily into exporting and that derive a large portion of their sales overseas. They’re not hard to find: corporations in the S&P index derive nearly half of their revenues from foreign sources. A good example is International Business Machines.

Many stock strategists believe large cap stocks will outperform the market in the face of a weakening dollar. Large cap technology stocks in information technology may be the most likely beneficiaries. It’s reported that of stocks in the S&P 500, information technology stocks produce the highest proportion of revenues from abroad -- an average of 57 percent.

What about gold?

Fear induced by the falling dollar, compounded by doubts about both our fiscal and monetary policy, have caused gold, the standard inflation hedge, to soar to an all time high of over $1,550 an ounce. The falling dollar juices gold hedging because the falling purchasing power of the dollar in foreign markets causes the price of foreign goods to rise -- from a flat screen TV to a barrel of oil.

This suggests that another promising avenue for coping with a falling dollar is to invest in gold. Perhaps the easiest way to invest is through a gold ETF or a gold mutual fund, such as Fidelity’s Select Gold Portfolio. This mutual fund, heavily invested in gold mining stocks, has appreciated 27 percent in the last year.

Gold is a volatile investment -- in both directions. We’ve previously discussed its investment merits, suggesting that it should be a relatively small portion of most investor’s portfolios.

Commodities other than gold also can serve as a hedge against the falling dollar, especially commodities coming from foreign countries. Absent specialized knowledge about a particular commodity, the average investor usually will be better off with a basket of commodities rather than trying to pick a particular winner. Again, the easiest way to invest in a basket of commodities is through ETFs or mutual funds. For example, the T. Rowe Price New Era mutual fund invests in foreign and U.S. natural resource companies, with a heavy weighting in energy resources. The shares were priced at $52.16 on January 1, 2011 and at $57.47 on March 31, 2011.

What about bonds?

Last month we discussed TIPS, Treasury Inflation Protected Securities, that provide increases in principal linked to the consumer price index. Over time, a falling dollar puts upward pressure on the consumer price index, so that TIPS are a hedge against both inflation and a falling dollar. Whether or not they are currently overpriced is a difficult call and last month we provided a rule of thumb to help in making that judgment.

Bonds with fixed principal are now problematic, especially longer term bonds. As inflation increases, pushed in part by the falling dollar, interest rates will rise, driving down the price of bonds because interest rates and bond prices move inversely. So far the effect on bonds has been negligible. For example the yield on the Treasury’s 10-year note has barely moved since the end of last year, despite the uptick in inflation. That won’t continue if inflation becomes more pronounced.

For conservative investors, high quality bonds of foreign government and corporate issuers warrant consideration as a hedge against the falling dollar. Because their principal is denominated in the issuer’s foreign currency, their value in dollars notches up if the dollar falls against that currency. For example, the Canadian dollar has risen 4.6 percent this year against the U.S. dollar and a $100,000 Canadian government debenture priced at $100,511 on January 1, 2011 was priced at $ 102,842 on March 31, 2011. In addition to buying foreign bonds directly, which carries individual country risk, you can buy global diversified bond mutual funds.

An important caveat: hedges don’t work in reverse. While it seems unlikely, the dollar could switch directions and rise against foreign currencies. If this occurs, the hedging steps described could result in losses. To protect against this, vigilance is required. If the factors causing the dollar to decline and inflation to rise are reversing, unwinding the hedges may be called for.

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