Three ways to profit from the yen

published 18 September 2007

For several years now, hedge funds and Japanese housewives have made seemingly easy profits from the yen carry trade, where investors borrow the Japanese currency cheaply the official interest rate set by the Bank of Japan is only 0.5% to invest in assets in other, higher-yielding currencies, such as sterling (5.75%) or the New Zealand dollar (8%). The yen's weakness has been underpinned by a lack of confidence in an economy teetering on the brink of price deflation Japanese consumers seem to prefer saving to spending which has helped keep interest rates low. But times are changing: the recent credit crunch has hammered asset markets, forcing traders to unwind carry trades as they become more risk-averse. And the Japanese economy, despite recent wobbles, still looks better-placed to ride out a credit crunch than its Anglo-Saxon counterparts. Barclays Capital reckons the yen will end the year at 109 to the dollar, from about 115 now. So how can you profit from this?

Place a currency spreadbet

Spreadbetting is probably the easiest way to bet on the yen. You can bet a fixed amount per "point" (0.01 yen) on the currency appreciating against, say, the US dollar. Don't forget that you are betting on the direction of the so-called "base" currency in a pair the one on the left-hand side. So if a broker offered you a USD/yen quote, you would ask to sell it (meaning you think the US dollar will weaken against the yen). But remember, when spreadbetting you can quickly lose far more than your original stake so use a stop-loss.

If spreadbetting strikes you as too risky, you could buy Japanese shares. The right stock could deliver a double return via a rising share price and a strengthening yen. Say you spend £1,000 on Japanese shares for 200,000 at a rate of £1:200. And say the firm's performance is mediocre and the share price doesn't actually move but the yen strengthens to £1:180. Your yen investment is now worth £1,110, an 11% return. But which stocks have the best prospects? Avoid exporters, who will be hurt by the rising yen. Chris Burling of the New Star Japan Recovery fund likes two stocks that have done well on the back of infrastructure demand in the major cities, particularly Tokyo. Daibiru (8806) leases office space and apartments and trades on reasonable price-to-book ratio of 1.4 with a p/e of 24; Central Japan Rail (9022) is a transport and property company on a current p/e of 20.

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Of course, while you can buy individual stocks (Barclays Stockbrokers is one broker that can access the market), dealing charges can be pricey and the cost of single shares higher than most British investors are used to. An easier way in is to buy a fund. The best mid-term bet is smaller funds invested in domestic, rather than export-orientated, stocks. Performance so far this year has been weak so now could be a great buying opportunity. Two of the best over the last five years, says Trustnet.com, are the Baillie Gifford and Legg Mason Japanese Smaller Companies funds.

It may seem an odd tip, but one way to profit from the rising yen, says Reuters, is to buy silver. As the yen strengthens, Japanese investors are taking advantage by buying dollar-denominated silver and gold. The stronger the yen gets, the cheaper the metals look to the Japanese particularly at a time when both are in demand for their safe-haven' properties. We like both, but Pradeep Unni of Vision Commodity Services in Dubai reckons "the potential for silver to rallyis significantly higher than gold". He believes silver could hit $14.75 by the year end.

We like gold and silver. Yet we are bearish on the dollar, in which both metals are priced. So aren't we contradicting ourselves? Well, no. That's partly because there's little choice; most commodities are priced in dollars, like it or not, so there is no sterling alternative. But we expect the profits from rising gold easily to beat any drop in the value of the dollar against sterling. Over the last four years the gold price has risen in sterling terms from £215 per ounce to a little under £340, a rise of nearly 60% in a period where sterling has strengthened from $1.6 to the pound, to more than $2. Also, although we expect the dollar to keep falling, the UK's heavy exposure to the credit crunch is bad news for sterling too. The two currencies weakening to some degree in tandem will soften the impact of a declining dollar on your overall return.

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Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.