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Hong Kong Dollar a Great Safety Net

By Sean Hyman   |   Monday, 29 Sep 2008 11:34 AM

With all of the craziness in the financial markets out there right now, I got to thinking about where the safest places were out there. Now, I know you can never say something is 100 percent safe, but this idea is about as safe as it gets.

Normally, a currency that has a controlled exchange rate (aka pegged exchange rate) isn’t one of the most attractive places for investors. But the Hong Kong dollar is one of the few major exotic currencies out there that has still has a peg.

A peg can help to protect investors especially in these shaky times in which we live where a housing crisis, banking crisis, and credit crisis are all in full swing.

Not only is the Hong Kong dollar peg helpful, but also their housing market is a lot more stable than that of most any other country. Why? Because their monetary authority requires that buyers put at least a 30 percent down payment on a house. This way they have some instant equity and a huge vested interest in their home.

Compare that in a day when many mortgage lenders around the world went out on a limb and required no down payment and no documentation of their income. Wow! Now there’s a stark difference.

By the way, the Hong Kong dollar made it through a similar crisis as the world is going through now back in 1998 with the Asian contagion (which was an Asian currency crisis). The sound housing market and their peg to the U.S. dollar was a safe haven for Hong Kong at the time.

However, their monetary authority went into the financial markets in 1998 and bought up US$15 billion worth of stock to defend their dollar and to protect their economy.

Did it work? Yep! As a matter of fact, within 2 1/2 years, the bank had recouped all of the money from the shares they purchased by selling shares and collecting dividends.

Of course since that time, the Hang Seng index has almost tripled off of its lows. So I find it interesting that the United States finds itself in the same position today. Maybe we should take a lesson from the Hong Kong Monetary Authority (HKMA).

Anyway, back to the safety of the peg. Hong Kong’s dollar has been pegged to the U.S. dollar since 1983. However, they have altered the rate at which it has been pegged at over those years.

These days, they also let it float within a controlled band. When the USD/HKD pair gets to the bottom of its band, the HKMA goes in there, sells HKD, and buys up USD. They have a $181 billion dollar pool built up just to do that.

The same goes for when the USD/HKD gets to the top of its band (which rarely happens). In those cases, they would sell the USD and buy HKD.

The HKD is pegged at 7.80 but allowed to float within a range of 5 cents on either side of that peg. So that makes it to where it’s technically allowed to float between 7.7500 and 7.8500. However, in reality, so far it only trades between 7.7500 and 7.8300 and never really makes it up to the very top of the allowed band.

Well lately, the USD/HKD pair recently traded down to the bottom of that band. And what happened? The pair has bounced off of that lower band once again.

This produces a protected downside in this pair as long as the HKMA’s $181 billion dollar war chest holds up. So that makes so there’s very little risk in owning this pair at this time.

Plus, you know you’re on the side of the pair that the central bank prefers you be on (and in the direction that they will be trading the pair if an intervention was needed). So, you have that going for you as well.

This pair is about 200 pips or so off of its lows as of this writing. But it has about 700 pips (or 500 more pips) of potential upside to the trade before it reaches the point at which it normally turns down.

Typically it will spend some months inching up towards the upper end of its range. So there should be plenty of time to enjoy this trade.

So while many financial assets out there are extremely volatile and headed south, here’s one safe haven currency pair that offers minimal downside risk while offering a good reward in its potential upside growth.

Plus, since their housing and currency are both more stabilized than that of most countries in the world, you won’t see as much volatility in this pair as you are seeing in many currency pairs and equities around the world right now.

This makes the USD/HKD a great buy at this point. It should have no trouble reaching 7.8100 and possibly 7.8300 over the coming months.

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SeanHyman
With all of the craziness in the financial markets out there right now, I got to thinking about where the safest places were out there. Now, I know you can never say something is 100 percent safe, but this idea is about as safe as it gets. Normally, a currency that has a...
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