Two Currency Plays for a Homely Market

I find investment ideas by opening my eyes. I look at a ton of stocks. I look at indexes, ETFs, futures contracts and mutual funds. And, by and large, I look for ideas that are doing well. After all, if an investment is going to perform for the "long haul", it should start by performing in the here and now.

This is an industry that runs on bright new ideas. That's made the dearth of plausible buying opportunities over the last few weeks that much more striking.

There are some notable exceptions: State Street (STT), for example, among financial stocks, and Becton Dickinson (BDX) in the health-care space stand out as unusually strong. But right now, it's a low-probability environment for equities.

What does "low probability" mean? Consider that you probably wouldn't go to the ugly girl contest to try and find the one pretty girl. You might have more luck at a beauty pageant. So I don't dig through a pile of weak stocks looking for the one that isn't homely. I'd rather wait for the entire asset class to improve its performance.

And while stocks might have stalled, if you've so much as glanced at the business section lately you probably know that other asset classes — commodities, Treasurys and foreign exchange — have been much stronger.

And while I believe that you should follow the tape instead of fighting it, it's possible to take this too far. For example, some gold investors are gradually overcome by a quiet mania that festers and grows until a portfolio has much too much of the yellow metal.

When not much else is moving, this type of concentration can be tempting. In fact, the same dogmatic portfolio overload has also occurred with foreign stocks and energy, just as it did with technology back in the 1990s. The lesson isn't to avoid hot areas but rather not to let a position in XYZ become your only position...even if the only other alternative is cash.

In that spirit, I've lately been intrigued by a pair of off-the-radar structured currency products traded on the American Stock Exchange. Both offer upside exposure to baskets of exotic currencies along with a limited downside — essentially a call option packaged into single security form. The weakening U.S. dollar has received a lot of play since I wrote about this trend a few years ago. But against the Asian currencies in particular it likely hasn't seen its lows just yet.

Citigroup Global Markets Group of Asian Currencies (CAQ) is a principal-protected note whose return is based on the performance of the South Korean won, Thai baht, Indian rupee, Taiwanese dollar and the Australian dollar. As these currencies rise (or fall) against the dollar, so does the price of CAQ. The major benefit of using the structured product over simply trading the currencies in the spot market is that at maturity, the note, now trading at $10.72, is protected to pay out at least $10 per share. So your downside is limited. One caveat is that the note comes due on April 28, 2008, meaning this particular security only has a few more months left before it matures. The full prospectus can be found here.

Merrill Lynch offers a similar security in the Principal Protected Global Currency Basket (GBO), which is based on a currency basket in which the Korean won, the Russian ruble, the Singapore dollar and the Chinese yuan each constitute 25%. This note too is principal-protected at $10 per share, meaning that even if the currencies plummet you'll be assured no less than $10 at expiration, which is Feb. 9, 2009. Interested investors should delve into the product's prospectus for more details.

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's fund held positions in many of the securities mentioned.