How to profit from a declining dollar

published 8 December 2006

As former US treasury secretary John Connolly once said, the dollar is "our currency, but your problem". The greenback has hit a 14-year low against sterling just shy of $2 and there's ample scope for further falls. Economists reckon it needs to fall another 20%-30% to make a real dent in the US's unsustainable current-account deficit. But the consequences for UK investors may be more serious than "the prospect of cheaper iPods for British tourists" visiting the US, as The Guardian puts it. Below, we look at how a weaker dollar can affect your investments and how you can profit from the trend.

Dollar weakness: beware UK earnings

A sliding dollar isn't just a problem for those holding dollar-denominated assets. Around 33% of UK company earnings are sensitive to the greenback, says Citigroup, implying that a 3% rise in sterling could wipe 1% off earnings growth. What's more, about 20% of the FTSE 100's revenues are earned in dollars. Since many UK firms have most of their costs in pounds, this means they become less competitive if they sell to the US and/or Asia. Another problem is that dollar revenue falls in value when translated back to pounds.

But as far as the overall market is concerned, a sliding dollar doesn't seem to be a key driver of returns: Citigroup notes that, since 1980, in years when the pound has gained an average of over 5%, earnings and stocks have actually exceeded their average performance over the past 26 years. However, that's not to say there won't be problems at sector and stock level. The most vulnerable sectors to a weak dollar are pharmaceuticals, oil, engineering, beverages and media, says Citigroup. Industries with largely domestic exposure include fixed-line telecoms and retailers; those worried about a weak dollar should stick to these. Shire, Amvescap, Tomkins, Signet, Pearson and Carnival top the FTSE 350 list of those most exposed, with dollar-based sales comprising as much as 82% of the total.

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Look out for firms with direct exposure to America's car-making, housing and consumer sectors, warns Charlie Dove-Edwin of QuantMetriks. Stocks like Lair, Signet, Wimpey, GKN and Tomkins suffer a "double whammy"; their products become uncompetitive abroad and their sales slide in value when converted back to sterling. Also note that some major firms report and set dividends in dollars, including HSBC, AstraZeneca and BP. That cuts the value of payouts in sterling terms so "investors could find their dividend income is worth about 10% less this year", says David Budworth in The Sunday Times.

A high-reward, if high-risk, way to cash in on the dollar slide is to spread bet. Allmajor spread-betting firms offer punts on currencies. At Tradindex.com, for example, you can bet for as little as £1 (or as much as £100) a point (in this case, $0.0001) on cable's position on 13 December. On Monday, the site was quoting a spread of 1.9787-1.9797. An investor betting on further appreciation of the pound would have been able to "buy" at 1.9797. A rise to $2 from there with a £1 stake would net a profit of £203 (203 times £1 per $0.0001). But if you get it wrong, you can lose far more than your initial stake, so taking out a stop-loss is a wise move.

Given Asian central banks' history of currency intervention, the euro seems likely to bear the brunt of the dollar slide. Bernd Meyer of Deutsche Bank suggests that, unless there is a very sharp near-term rise in the euro, the gain in the euro's value could make euro-denominated assets attractive enough to investors to offset any impact on company earnings. The fact that European equities still look relatively cheap and have only moved in the same direction as the dollar in three of the past eight years may create interest in Euro-denominated assets. So European stocks sheltered from the dollar's slide, such as utilities and financials, may be worth a look. One such stock is Unicredito Italiano (UC, e6.50 in Milan), the biggest bank in fast-growing central Europe; all its revenues stem from Europe. It yields 3.4% and Merrill Lynch rates it a buy. Wirtschaftswoche likes IKB (IKB, e30 in Germany), a German lender to smaller firms that's profiting from a business investment recovery.

When the world's most important paper currency looks shaky, people turn to gold. Although gold is denominated in dollars, the rise in its price amid sustained dollar weakness is likely to outstrip any corresponding dollar slide. After all, the euro is hardly a compelling alternative to the world's ailing reserve currency as it has existed for just six years and one of its constituents (Italy) is an economic basketcase.

Gold, on the other hand, has been used as a currency, and maintained its value, for millennia. On top of this, mined supply is set to remain almost static over the next few years, while demand rises, notes Mark O'Byrne on Dailyreckoning.co.uk. Gold exchange traded funds have made gold more accessible to Western investors and jewellery demand will jump as China and India's middle classes grow. There is also ample scope for developing central banks to raise their gold reserves China's gold holdings comprise just 1.3% of its total reserves, against the 3%-5% range typical elsewhere. An easy way in is through the Lyxor Gold Bullion Share (LSE:GBS).

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.