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ETF Securities Currency Research – Investors need to know about currency volatility
Investing should be a conscious decision by individuals. However, there is a critical part of the investment decision that many investors in foreign assets are not taking into account: currency movements. Most investors trade currencies, but often it is not an active decision. Regardless of the asset class, if an investor is purchasing offshore assets, a currency transaction is being entered into and if this is not taken into account, risk is being understated.
Any offshore investment involves a currency position, unless it is offset by hedging. Whether it is US or emerging market equities, commodities or bonds, any investment that is a denominated in a foreign currency for the investor will involve a currency exposure. It is important for investors to be fully aware of the currency exposures within their portfolio, as it can have a significant impact on investment returns.
As seen in the following chart, the currency component of US equity returns has been significant and varied. The example highlights the returns from a US equity portfolio in 2015, from the perspective of a UK investor. An investment in the MSCI US index would have returned nearly 5% over the course of 2015, largely due to favourable currency movements. The US Dollar strengthened nearly 6% against the British Pound in 2015, offsetting the -0.75% decline in the underlying US equity benchmark.
Although overall the currency movements in GBP/USD and EUR/USD have been favourable, because of the broad based strength in the US Dollar in 2015, there has been significant volatility of currency returns on a month to month basis. This volatility and the resulting magnitude of movements in the currency markets have made the topic of currency hedging a key investment theme of 2015.
The Fed’s rhetoric indicates that the central bank is likely to continue its gradual rate hike path in 2016. The market continues to discount the appetite for the Fed to raise rates, expecting just one rate hike by year-end. In turn, near-term strength could turn into longer-term weakness for the dollar.
Indeed, if, as we believe, the USD peaks by end-Q1 2016, investors will need to be closely attuned to the level of currency volatility and the potential for a falling USD to have an adverse impact on portfolio returns. Our expectation for a USD peak in coming months suggests investors in foreign assets should look to hedge foreign currency (particularly USD exposures).
While currency volatility has softened in early 2016, it remains elevated from a historical perspective. During the remainder of 2016 a number of factors look set to keep FX markets unsettled. Thus, international asset managers need to remain conscious of inherent currency risks they may assume through offshore assets, because currency movements are rarely neutral.
As an asset class, commodities are unique for non-US investors: the investable universe is denominated in US Dollars and therefore should be considered by any non-USD denominated investors as a foreign asset with inherent currency risk. The majority of commodity investors situated outside of the US are therefore directly exposed to currency fluctuations. Unless a commodity investment is hedged, movements in the exchange rate between the US Dollar and the investor’s own domestic currency, directly impact the returns from commodity investments. For example, in 2015 the price of gold fell by 10.5%, but for European investors this loss was limited to 0.3%, due to the 10.2% appreciation of the US Dollar against the Euro over the same period.
While currency movements can impact commodity returns, the two asset classes also have other linkages. The highly publicised slump in commodity prices has been a contributing factor to the current elevated level of currency volatility and looks set to remain a catalyst for further currency gyrations in the year ahead.
Commodity prices can impact currencies through inflation dynamics. In particular, the current low price of energy is depressing inflation expectations and is making the future path of global monetary policy less predictable. Central bank activism has been a key driver of currency market movements and the prospect of increasingly uncertain monetary policy is likely to keep currency volatility raised.
In addition, falling commodity prices have damaged the terms of trade for commodity exporters globally and the impact is unlikely to be short-lived. Reduced investment and job losses in resource sectors worldwide will continue to filter through to economic performance throughout 2016 and create instability for currencies underpinning exporting nations.
Uncertainty surrounding China and lapses in confidence can cause sharp appreciation of currencies that are traditionally considered a safe haven, such as the CHF and JPY. Investors with exposure to safe haven currencies or EM currencies directly should be aware of the effects that a short term crisis of confidence can have on these currency markets.
These factors have potential to maintain currency volatility at elevated levels throughout 2016 and should give investors pause for thought regarding the source of investment returns for foreign assets in the year to come.
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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Celebrating Gold ETPs In 2003, ETF Securities listed the world’s first physically-backed gold exchange-traded commodity (ETC), on the Australian Stock Exchange (ASX) in 2003.
In 2005, ETF Securities created Europe’s first oil ETC and in 2006 established the world’s first commodities ETC platform, making 19 commodities and 10 commodity indices available on the London Stock Exchange and other European exchanges. In 2008, the Company listed the first carbon ETC on the London Stock Exchange.
More recently in 2013, ETF Securities listed currency-hedged physical gold investment products on the London Stock Exchange and the Deutsche Boerse and began offering the world’s first Gold ETP to allow physical redemption by retail and institutional investors.
The ETF Securities Group provides accessible investment solutions, enabling investors to intelligently diversify their portfolios beyond traditional asset classes and strategies.
We are pioneers in specialist investments, having developed the world’s first gold exchange traded commodity. Today we offer one of the most comprehensive ranges of specialist exchange traded products (ETPs) covering commodities, FX and thematic equities traded on major exchanges across the world. Using that pioneering spirit, our unrivalled expertise and by working with best-in-class third parties, we seek out the most relevant opportunities and make them accessible to investors as intelligent alternatives.
Five key strengths underpin what we do every day and all of them working together is what makes us different, specialist and unique – the intelligent alternative.
What Happens When Fundamentals Reassert Over Sentiment
The commodity cycle is turning – but commodity prices do not yet reflect the stronger underlying fundamentals. As sentiment realigns with fundamentals we believe there is scope for strong price gains.
Volatility has been a pervasive force in G10 currency markets with the ongoing Greek saga and prospect of tighter monetary policy in the US. Whilst sentiment has been a key driver of policy moves recently, we expect growth and policy fundamentals to become the focus in the upcoming quarter.
Tomorrow we will be hosting a webinar at 2pm (BST) to discuss these trends in commodity and FX markets. We will be joined by Sheryl King from Roubini Global Economics who will be looking at equity and fixed income trends for the quarter ahead. Register here
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
This communication has been provided by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the ”FCA”).
When being made within Switzerland, this communication is for the exclusive use by ”Qualified Investors” (within the meaning of Article 10 of Section 3 of the Swiss Collective Investment Schemes Act (”CISA”)) and its circulation among the public is prohibited.
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.
This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.
ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.