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Stocks, Currencies, and Your Profits (Part 1)

10 October 2007 - Features - Editor

Currencies can beat stocks when it comes to profiting by hedging, but this kind of trading requires a distinct set of skills. The inter-relationships between currencies, interest rates, trading balances between nations, and country policies, are intricate and complex. That is why trading in currencies has become such a specialized function, with risks as large as the acclaimed stories of windfall profits. A majority of retail investors stay away from investing in currencies, and even large institutions prefer to reserve this tricky domain for experts. However, globalization of business has changed all this, and most investors must go back to school, at least, in an informal sense, to understand the nuances of currency movements on stocks.

Even a mom and pop store may be deeply affected by swings in exchange rates, if for example it deals in products and services with large components of imports. Finished goods on shelves may be indigenous, but may contain substantial imported components and raw materials. Customers, suppliers, sellers, financiers, and wage bills of large companies can also be buffeted unexpectedly by changes in relative currency values. Most countries now allow market forces to determine market forces to determine the relative values of their home currencies, but China is an influential exception to this norm. The Chinese government manipulates the value of the RMB so as to gain advantages for its exports.

Therefore, buying from or selling to China has additional currency implications.

Exports, Imports, and Stocks

Every investor must have comprehensive information about the imports and exports of all companies in which he or she holds stocks. Statutory financial disclosures do not provide comprehensive details of all the currencies which influence performances of stocks, so investors must dig out this information from data about a company’s key customers and important items of purchase. An ideal situation prevails if a company’s revenues are evenly spread across a number of developed and stable economies, or if the product or service offering is relatively price insensitive. Conversely, returns from stocks of generic producers which are heavily dependant on one country or another, are always suspect because exchange rate fluctuations can make quick and deep in-roads in to profits. Similarly, products and services with high dependence on imports from selected sources can lose market shares rapidly if exchange rate conditions are turbulent. Some currencies are tied to baskets of others, making the situation even more complex and difficult to predict. Finally, the matter is fluid so conclusions which were developed even in the recent past can become irrelevant quickly. Investors must question the impacts that foreign exchange movements may have on business performances in future quarters, and about the hedging strategies of companies in which they hold stocks.

 


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