Get Current on Currencies

Why the money of other nations is becoming an asset class rather than a commodity

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Illustration by Gluekit for TIME; From Left: Alamy; Getty Images (4)

Growth is slow. Government debt is way up. Interest rates in many developed countries — the U.S., England, Germany and Japan — are at historic lows. And, at least in the U.S., there is a growing paranoia that inflation will soon devour everyone. Put it all together and that makes this a great time to invest in — currencies?

Investing in government tender used to be a high-wire act, the exclusive province of professionals executing leveraged arbitrages. But today it's more about betting on megatrends — for instance, the possibility of some developed country going belly-up. Or a new global leader rising. That's why a growing number of investors, both big and small, are getting interested in the currency market. The market for trading dollars for, say, Japanese yen or Turkish lira has more than doubled in the past six years, to $4 trillion a day, according to a study by the Bank of International Settlements.

Some of those investors have done very well. The value of the Australian dollar compared with the U.S. dollar is up 35% since the beginning of 2009. The Brazilian real is up 15% from a low in January. And even the yen, the currency of the beleaguered Japanese economy, has been hot lately — up 7% in the past six months, despite the government's efforts to buy it down. "Currencies are one way to make money at a time when the financial markets in general have been very lethargic," says Louis Stanasolovich of Legend Financial Advisors.

Sour stock markets, though, are only part of the currency story. First of all, it's easier to trade currencies than it used to be, and there are more flavors to choose from. A number of governments have ditched the dollar peg and allowed their currency to float more freely, inviting foreign traders to participate in their markets. For individuals, opening a margin account and learning futures contracts — a potentially hairy and expensive proposition — is no longer necessary. There are 44 exchange-traded funds — up from just one in 2004 — that track the value of various currencies versus the dollar. A number of mutual funds also invest in currencies. "More investors are looking at currencies as another asset class, like stocks and bonds," says Ken Jakubzak, who runs a hedge fund in Lake of the Hills, Ill., and has been trading currencies for more than two decades. "It's another way to diversify."

But the bigger trend pushing currencies is this: developed nations look tapped out; commodity-rich nations are booming. China and India's middle classes are growing. Africa is blossoming. Currency markets give investors the ability to bet that the leadership of the global economy is shifting, and that's a bet more and more investors want to take.

Currencies are even looking less volatile than stocks. Some currencies, like the Chinese yuan, which is up 20% in the past five years, have risen. But they haven't had the run experienced by stocks in China, which, despite their recent drop, have soared over 110% in the same time. "Most people still believe China's yuan is undervalued," says Jeff Feig, a head of foreign-exchange trading at Citigroup. But there are dangers in this emerging asset class. With all the new entrants, volatility has increased. And governments have been known to manipulate their currencies, as Japan has recently begun to do to protect its exports.

Still, a number of strategists say having a small portion of their assets in foreign currencies is a good idea, if only for protection against a continuing fall in the value of the dollar. Morningstar analyst Michael Rawson suggests the Powershares DB US Dollar Index Bearish ETF, which tracks a basket of developed foreign nations' currencies, including the yen, euro, Canadian dollar and Swiss franc. But more risk-averse investors might want to try the WisdomTree Dreyfus Emerging Currency Fund ETF, to play on the shift in the global economy. "Currencies are not a productive asset, but for a small portion of a large portfolio, about 3%, it may make sense," says Rawson.