Exchanging Places

A lot of people are interested in currencies or gold. With Exchange Traded Funds linked to currencies, it’s easier than ever to take a position on the dollar. For those who might consider this, I have just one piece of advice: don’t.

When you look at an investment, you need to understand what you’re buying. In a market economy, wealth is created by enterprise. Stocks represent ownership of those businesses. Bonds are loans to those businesses—or the governments that support them. Investments in stocks and bonds (and funds that hold them) represent claims on the cash flow that these businesses will generate.

The value of a stock or a bond, then, is just the discounted value of the expected future cash flow, adjusted for risk. The problem with currencies or gold or baseball cards is that there is no future cash flow. There’s only an expectation of what someone else will pay. It’s a beauty contest

Sure, the temptation is strong to see a trend and jump on board. Like everyone else, I’ve watched the euro fall lately as fears of a break-up have moved the currency. But I used to trade currencies for a bank, and sentiment can turn on a dime. A year ago, everyone was a dollar-bear because of our deficits. Now everyone has become euro-skeptics. What will happen next? Who knows? Unlike a business, there’s no expected cash flow to fall back upon.

When most folks trade currencies, they’re just guessing. In general, the easiest way to win in such a market is not to play.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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