Over the past year, all financial markets have been volatile. Investors have become risk adverse and gone into beaten down currencies and U.S. Treasurys.
However, the volatility that has caused emerging currencies to dive like a rock and the U.S. dollar to rocket upward against them seems to be about over. The volatility, as measured by the VIX (Volatility Index), had a reading as high as 90 in October. Today it's at a level just under half of that (43 as of this writing).
Since volatility has been cut in half and the global stock markets have gone into a sideways range, money has begun to tip-toe back out on the risk curve in search of higher yields.
Where are those high yields to be found? Normally, you'd look to the New Zealand dollar and Aussie dollars first and then on to currencies like the British pound and euro. However, every one of these countries seems to have their interest rates headed lower.
This has helped to bring more appeal to the emerging market currencies. Many of these, like the South African rand and the Turkish lira, have annual interest rate yields as high as 14 percent to 15 percent now. Compare this to New Zealand's 3.50 percent or the euro's 2 percent and you can see where the appeal is coming from.
It's true that emerging countries have lowered rates too, in the 16 percent to 20 percent range, but the rates are still higher than those of the major industrialized countries.
Also, the rate of inflation in these emerging economies is still far higher than that of these industrialized currencies. When you have higher rates of inflation, a central bank is slow to lower rates and quicker to increase rates.
So as long as markets remain somewhat stable and volatility doesn't make new highs, then you're probably going to see a new trend that is starting now to continue on toward emerging markets currencies.
If the Obama stimulus package passes, then this should also be a green light for riskier investors to wade back into the emerging market stocks and currencies.
As investors from the United States and other industrialized nations seek higher returns by investing in emerging markets, they have to sell their home currency (dollars, euros, pounds, etc.) and buy the emerging market currencies (the rand, the lira, etc.). Whether this money goes into the emerging market bonds or stocks or other ventures, the thing that is "a must" is that their money be exchanged into the home currency of the country they're investing in.
Therefore, as markets continue to stabilize and eventually head higher, you will see the trend that has recently started continue, which is for money to find its way back into these emerging markets.
The currencies that will benefit the quickest will be the ones that yield the higher interest rates. Investors know that these will be the currencies that will become the most stable and will also be among the first to start increasing in value.
Foreign investors can make money two ways: They can make money in the currency they are using to invest as it goes up in value (rand, lira, etc.), and they can make money in the bonds or stocks that they are in as more money flows back into those countries.
When market fears die down, these emerging stock markets and emerging currencies benefit. When bear markets strike up all around the world, these currencies and stock markets get punished first and usually get hit the worst.
So, don't be surprised if you start to see the U.S. dollar and yen languish and these emerging currencies start to perk up. When you've had stock markets crash for over a year and you've had them drop in excess of 40 percent, there's a good chance statistically and from a historical point that the worst is over.
While markets may not instantly head higher, since they are still licking their wounds, as long as they are somewhat stable these emerging currencies will flourish.
The daily dividend that they put out will once again make the risk worth taking. If you get a 15 percent annual dividend but the investment drops 40 percent, then it's not such a good deal. This has been the case in the past year. However, even if the currencies now tread water for a bit but you get a 15 percent annual dividend, then it suddenly becomes a risk worth taking.
Not only are these currencies likely to be stable over the next 12 months but they are also likely to appreciate once again. So any appreciation above the huge yield is simply icing on the cake. Savvy investors realize this and that's why the process is starting even now.
Many investors won't realize this is happening for quite some time. Until the media starts touting it, they don't awaken to the idea. However, once the media catches on to it, much of the move will already be over.
This is why I like to let my readers know of these things early on. The quicker you catch a trend, the less risk it poses. The longer you wait to get into it, the more risk it poses because the potential remaining upside is much more limited at that point.
So be open to the emerging market currencies once again, especially the rand and lira.
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