Teetering Dollar Bodes Well For Currency Funds

Dow Jones, September 7, 2005

With the dollar starting to look like it could be on the brink of going back into freefall, currency investors are tentatively rubbing their hands.

Clear, steady trends in major currencies are just what many foreign-exchange funds need to make good returns, whereas choppy, range-bound markets frustrate their efforts to place winning bets.

That's why currency investors are already showing nervous signs of optimism after a difficult few months. If the dollar downtrend gains further momentum, 2005 could work out better than feared.

"The speculative community loves jumping on a lower dollar," said Glenn Stevens, managing director at Gain Capital Group, a Bedminster, NJ-based firm that offers foreign-exchange trading services and runs two currency funds.

"For some reason, a down dollar attracts more speculative interest than a strong dollar. It's a psychologically easier trade," he said.

With the euro bouncing from its low of $1.19 in July up to around $1.25 now, those speculators have reasons to be cheerful.

But many are still in wait-and-see mode.

"There does not appear to be big positioning going on," said Paul Chappell, chief executive of currency hedge fund C-View. "The market is awaiting more evidence before getting really involved. It's a bit frustrated."

That's because savvy market participants know the dollar's recent fall could easily reverse.

"It's a very rapid move up, and that doesn't fill me with confidence," said Julian Knight, the London-based global head of foreign exchange sales and distribution at Man Financial, which runs funds and brokerage services.

But, he said, fairly robust U.S. payrolls data released late last week failed to give the greenback a meaningful boost. "There was a tiny pullback (in euro-dollar) but people do seem to be trying to establish new dollar shorts," he said.

To date, there have been no key U.S. data that were gathered after Hurricane Katrina hit Louisiana, so it's difficult to assess the impact on the country's economy and interest rate outlook.

When more detail emerges, the potential direction for key currency pairs like euro-dollar should become clearer.

Trend-following funds are hoping it will, as 2005 hasn't been kind to them so far. Many lost a lot of money early this year when the dollar climbed, because they were still positioned for it to fall.

Even when all the data backed up the strong dollar trend, funds just kept betting against it and losing money. "All the ingredients were there but the dough didn't rise," said Stevens at Gain.

By May, the 60 or so currency funds that contribute to the Parker FX Index of funds' returns were down nearly 5% in the year to date. By the end of July, they had made up some ground, but with markets range-trading in the summer lull, they were still down by 0.57%.

"It was a tough start to the year, and the fact that there has been a lack of a clear trend has not helped matters," said Ian Stannard, a currency strategist at BNP Paribas who tracks funds' performance.

"Certainly last year the strong trend at the end of the year came to the rescue of many funds, and I think it may be the case this year," Stannard said.

But if there is a strong new trend like last year's, which took the euro roughly from current levels in late summer to a peak of over $1.36 by the end of December, not everyone will win.

Shorter-term players like Gain rely on those choppy conditions that the majority of the currency-fund community - the trend-following funds - find so difficult to navigate.

Gain's Stevens is hopeful that if a new trend does emerge, it won't be in a straight line, providing some of the choppy conditions he needs. "There's going to be a lower dollar, but with quite a few fits and starts within it," he said.

A lot of funds closed for business earlier in the year, he added, and "there's a feeling that the ones that made it through that mess are going to do well."

But whether funds love trends or hate them, they're on high alert to spot them emerging now. "From a seasonal standpoint, September and October is when you do get moves in currencies, so it's likely that if the evidence shows whether Katrina has had a significant impact, there could be a sizable move," said Chappell at C-View.

That would likely receive a broad welcome from the currency fund community.

"Given that a large proportion of the money invested in currency funds is in trend-following strategies, the market as a whole would prefer to see clear trends because the returns would be higher," Chappell said.

With many accounts still broadly neutral on the dollar according to positioning data, if a dollar drop starts in earnest, there are still plenty of funds left to get on board, so the move could quickly accelerate.

"There is a chance for a self-fulfilling prophesy here," said Stevens at Gain. "In a down-dollar environment, the move could then get amplified because it attracts more speculators. You get asymmetric momentum."