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What's Next for Currency ETFs?

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Although many investors overlook currency ETFs, these products can usually tell us a lot about equity performance. Generally speaking, when the dollar is surging it can lead to a weak equity market, while the opposite is often true with a weak dollar.

This has not been the case to start 2013 though, as the main dollar ETF, the PowerShares US Dollar Bullish Fund (UUP - Free Report) has been powering higher along with the broad stock markets. Not only that, but UUP has actually broken through its longer-term moving averages, suggesting that bullishness could be in this ETF’s future as well (read PIMCO Debuts Active Currency ETF).

Behind the Surge

Yet as promising as the surge has been in UUP to start 2013, investors should note that a great deal of the dollar’s power has been due to other currencies’ weakness, instead of the greenback’s strength. In this case of UUP, this really centers on three currencies which take up the bulk of the exposure, the euro (FXE - Free Report) , the yen (FXY - Free Report) , and the pound (FXB - Free Report) .

Together, these three make up nearly 80% of the fund’s exposure, and all of these currencies have seen trouble in the trailing three month period. Consider the chart below which plots the dollar ETF against the other three major currency funds, and you can see how the dollar has really been riding high on the pound and the yen’s weakness as of late (also see Is it Time to Buy the Hedged Currency ETFs?).


Bottom Line

We think that this trend could continue, largely thanks to how weak many of the foreign markets are appearing against the dollar at this time. Furthermore, this trend shouldn’t be too much of a concern to equity investors, as it is more a reflection of foreign currency weakness, as opposed to broad dollar strength.

For more on this trend and the inner workings of UUP, investors should watch the short video below on the subject:

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