A weak U.S. dollar helps U.S. manufacturers, U.S. exporters and U.S. multinationals, writes Gary Gordon for ETF Expert. But a weak dollar means foreign exporters and foreign manufacturers are hurting as they try to sell to the U.S. market. (What’s so great about a weak dollar?)

For example, the strong euro is bad for business in the Eurozone. In August, exports dropped 6% from the previous month because of an appreciating euro. (More on the eurozone).

• CurrencyShares Euro Trust (NYSEArca: FXE): up 5.1% year-to-date

Japan is another country watching its currency appreciate. The Japanese yen is likely to stay stable since the island nation is heavily export dependent.

• CurrencyShares Japanese Yen Trust (NYSEArca: FXY): up 0.2% year-to-date

Both FXE and FXY are in an uptrend, tracking above their 50-day and 200-day moving averages.

As it stands, Europe and Japan don’t have much room to further decrease the value of their currencies through monetary policies since interest rates are already so low. Still, the U.S. dollar can’t go on depreciating forever.

For more information on world currencies, visit our currency category.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

Max Chen contributed to this article.

Most recently, policy makers have boosted foreign currency holdings by $413 billion last quarter, the most since at least 2003, to $7.3 trillion, report Ye Xie and Anchalee Worrachate of Bloomberg.  The currencies of choice are the euro and yen, which account for nearly 63% of new cash. Read more about using currency in your portfolio here.

The world is flush with dollars as the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors.  This, in turn, is making the dollar less of a diversifier for investors. To add to the currency’s woes, foreign corporations and economies are starting to feel the effects of a weak dollar, as well.

From an investor’s perspective, one can play the PowerShares DB Dollar Bearish (NYSE:UDN) which is up 7.6% year-to-date.

For a more optimistic approach, one can play the Euro through the Rydex CurrencyShares Euro Trust (FXE) which is up 6% year-to-date.

As for the yen, it can be played through Rydex CurrencyShares Japanese Yen Trust (FXY) which is up 0.4% year-to-date.

By holding non-dollar-denominated assets, such as emerging market equities, investors  can hedge against weakness. iShares MSCI Emerging Markets (NYSEArca: EEM) is up 60.9% year-to-date. Read about what emerging markets can do for your portfolio here.

A weak dollar can also be hedged with commodity ETFs, including United States Oil (NYSEArca: USO) and iShares COMEX Gold Trust (NYSEArca: IAU). Dollar-denominated assets tend to become cheaper for overseas buyers, which often leads to a spike in prices.

For more stories on currency ETFs, visit our currency ETF category.

Read the disclaimer, Tom Lydon is a board member of Rydex Funds.

For full disclosure, Tom Lydon’s clients own shares of EEM.

Kevin Grewal contributed to this article.

The Japanese yen is gaining strength, which is putting exporters on guard because of the threat it poses. Strategist Fumiyuki Nakanishi said the dollar-yen rate and the performance of exporters would likely determine the Nikkei’s direction this week, with the ultimate goal of keeping the ratio above 1,000.

Many analysts and insiders say it is not “right” to deliberately weaken the yen through market intervention, report Colin Ng and V. Phani Kumar for The Wall Street Journal. The dollar-yen rate and the performance of exporters would likely determine the Nikkei’s direction this week.

In response, Japanese government bonds were higher as Tokyo shares dropped steeply. The stronger yen may hurt exporters, but ETF investors can capitalize in a few ways:

• CurrencyShares Japanese Yen (NYSEArca: FXY): down 0.42% year-to-date

• WisdomTree Dreyfus Japanese Yen (NYSEArca: JYF): up 0.6% year-to-date

For more stories about Japanese yen, visit our Japanese yen category.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

The Japanese yen has been on an upswing in recent weeks as investors search for the safest assets. Deborah Levine for MarketWatch reports that the overall sentiment over the global economy, mixed with down Japanese data has been causing the yen to rally.

The Macro Trader on Seeking Alpha reports that although inflation will not be here tomorrow, governments have printed lots of currency. Until that money is circulating, the super inflation many anticipate will not kick in. Rather than seek the Japanese yen for its usual carry-trade appeal, many are turning to the yen as a safe haven from inflation.

Macro Trader notes that each time investors have fled risky assets such as stocks and corporate debt, they have flocked to the yen (among other things) as an alternative. The currency and fixed income markets are good indicators of high and low risk and could be a part of your strategy and trend following plan in tumultuous times.

• CurrencyShares Japanese Yen Trust (FXY): up 7.2% over three months

• WisdomTree Dreyfus Japanese Yen (JYF): up 7.2% over three months

For full disclosure, Tom Lydon’s clients own shares of FXY.

For more stories about the Japanese yen, visit our Japanese yen category. For more information about currency trading, visit our currency special report.

The Forex Market

The foreign exchange market, also known as the forex market, is the largest market in the world. In 2007, for example, it garnered $3.2 trillion worth of transactions each day. It’s the quiet giant of finance and dwarfs all other capital markets worldwide.

Unlike most other trading, such as futures, stocks or options, forex trading doesn’t happen on an exchange. It’s not controlled by any governing body, has no central exchange and there are no clearing houses involved guaranteeing trades. It’s a global network, made up of banks, corporations and individuals. The forex is also the most liquid market – there are always ready and willing buyers and sellers for the currency someone is seeking to trade.

The vast majority of currency trading is done bank-to-bank, and when each party enters into an agreement, they both take on the counterparty risk of the other. They’re not only competitors, but they’ve got to cooperate, as well.

There’s no actual buying and selling in the currency market – only trading, hence the need for cooperation.

Exchange traded funds (ETFs) have made entering this market much easier than it used to be. Prior to the launch of currency-related ETFs in 2005, the forex was a challenging market for individual investors to gain access to. Many investors might find this simplified access appealing, especially when you’re talking about a market that’s open 24 hours a day. If you’ve been eager to play this market, there are a rapidly growing number of opportunities to play the currency markets in the form of both ETFs and exchange traded notes (ETNs), which we’ll detail later.

Currency Basics

When entering the currency market, much of the focus is on the eight major currencies, which give you the best over- or under-valued opportunities. The eight major countries that make up the currency trading market are the United States, the Eurozone (Germany, France, Italy and Spain), Japan, United Kingdom, Switzerland, Australia, Canada and New Zealand.

There are many, many more currencies beyond the eight majors, such as the Brazilian real, Polish zloty and Hungarian forint.

Some of the key points to consider when you’re investing in currencies are:

• When trading currencies, yield drives return. Every currency has a yield.
• The forex allows huge leverage; often as high as 100:1 – which means that you can control $10,000 worth of assets with as little as $100 of capital. Remember, leverage works both ways, though.
• Since currency values never stay the same, the carry trade became a popular theory. Carry traders hope to earn not only the interest rate differential between the two currencies, but also look for their positions to appreciate in value. We’ll discuss this in more detail in the next section.
  
• Interest rates matter – a lot. Becoming familiar with the economics of the country in which the currency you are trading holds will help you understand when inflation is looming and when opportunity is knocking.

In currency markets, there’s always a bull somewhere. Why? The foreign exchange market is all about opposites and all about relativity. As one currency gains value, another has to be losing.

Dan McCabe, CEO at Next Investments, points out that one of the biggest advantages to investing in currencies is that it’s a great way to get non-U.S. dollar exposure.

“As an investor, I have nearly all my stuff in U.S. dollars. When I want to buy something, it’s often foreign-made. If I don’t have a hedge for the fact that the U.S. dollar may depreciate, I’m just losing my buying power on the world stage.”

For example, have a look at this five-year chart of the euro vs. the U.S. dollar. For the last three years, the euro steadily gained before falling off mid-way through 2008:

This means that as the euro gained strength, perhaps tourism in Europe suffered as Americans couldn’t afford to go over there and spend as much. But on the flip side, it likely brought tourists over here who were itching to spend and find bargains. Currency is all about relationships, and a currency being either weak or strong doesn’t necessarily mean it’s bad or good.

McCabe sees currencies as more of a buy-and-hold hedge instead of getting caught up in trading. “You’d rather just come in, buy it and put it away and look at it like a foreign money market account,” he says.

The Carry Trade

One of the most popular ways for institutional investors to play currencies is with the carry trade. Putting it simply, the carry trade involves borrowing currencies from countries with low interest rates and investing it in high interest rate countries. The strategy aims to take advantage of the wide spread in interest rates between certain currencies.

As of June 24, some interest rates for various currencies were:

• Australian Dollar, 3%
• New Zealand Dollar, 2.5%
• Euro, 1%
• U.S. Dollar, 0.25%
• Japanese Yen, 0.1%

You can track these interest rates at Daily FX.

With these interest rates in mind, an investor utilizing the carry trade would want to buy Australian dollars with the much lower-yielding Japanese yen, which is one of the most popular carry trade combinations around.

The carry trade isn’t a risk-free strategy, though. One of the biggest risks is if the exchange rate devalues by more than the average annual yield. If you’re using leverage, your losses could be even greater.

ETFs have simplified the carry trade for retail investors. The PowerShares DB G-10 Currency Harvest (DBV) tracks the interest rates of the U.S. dollar, euro, Japanese yen, Canadian dollar, Swiss franc, British pound, Australian dollar, New Zealand dollar, Norwegian krone and the Swedish krona. DBV looks at the three-month interest rates of the G10 currencies and goes long on the three with the highest rates and short on the three with the lowest. The ETF seeks to capitalize on the trend that the currencies with high interest rates generally tend to rise in value relative to currencies that have low interest rates.

Currency Risks

McCabe points out that currencies are non-correlated assets. “The risk you have oftentimes is performance vs. the underlying currency you’re purchasing in.”

As an example, assume that $1 equals 1 yen. If the dollar increases in value, you might get 1 yen for 90 cents – great if you’re traveling to Japan when this happens. However, it’s not so great if you have an asset priced in yen that you bought when dollars and yens were of equal value.

The flip side also works: if the dollar falls against various currencies, you stand to make money on assets based in those currencies if you bought them before the dollar weakened.

When searching for currencies to invest in, McCabe looks at the country behind it. Political upheaval can wreak havoc on a currency.

“I would look for a stable country with strong jurisprudence and rule of law…a country you believe is going to be stable, in case of turmoil.”

Why Use ETFs Instead?

Investing in currencies on your own, without an ETF, can be an arduous task. The currency market is one that never closes. Twenty-four hours a day, trillions and trillions of dollars in trades are taking place. You could find yourself sitting up in the middle of the night, waiting for a key signal to pounce on a trade.

That probably doesn’t sound like the average retail investor’s idea of a good time.

There are now two options for exchange traded currency investing: ETFs and exchange traded notes (ETNs).

Two key differences between currency ETFs and ETNs are:

1. Currency ETNs (like all ETNs) are backed by the full faith and credit of the issuer. If the issuer goes under, you have to get in line with all the other creditors. It’s a small risk, but it’s one to keep in mind.
2. Currency ETNs linked to a single currency are treated like debt for federal tax purposes, according to a 2007 IRS ruling. It means that any interest is taxable to investors, even though the interest is reinvested and not paid out until the ETN is sold or upon maturity of the contract. It also means that investors can’t elect capital gains treatment.

Not all exchange traded currency products are structured in the same way, either.

McCabe points out that it’s wise to be aware of what makes currency products different from one another. For example, Rydex’s CurrencyShares funds are grantor trusts – they hold the actual currency.

The interest earned on them is accrued on a daily basis and reinvested monthly. This reinvested interest is then reflected in the fund’s net asset value (NAV).

On the other hand, PowerShares‘ currency ETFs, PowerShares DB US Dollar Bullish Fund (UUP) and PowerShares DB US Dollar Bearish Fund (UDN), hold futures contracts and are registered as open-ended ETFs. Any gains from futures contracts are subject to 60/40 tax treatment, in which 60% of the gains are long-term, 40% are short-term.

In the bullish fund, the futures contracts are designed to be long on the U.S. dollar against the euro, yen, pound, canadian dollar, Swedish krona and Swiss franc. The bearish fund is designed to be short on the U.S. dollar against those currencies.

WisdomTree’s currency income ETFs invest in either non-U.S. moey market securities, or in a combination of money market instruments designed to provide exposure to non-U.S. money market securities or rates. They are not money market funds. They seek to give investors current income reflective of foreign money market rates available to U.S. investors, as well as exposure to changes in the value of a specific currency relative to the U.S. dollar.

Market Vectors‘ currency ETNs are senior, unsecured debt securities that give exposure to the exchange rate between U.S. dollars and foreign currencies. The underlying indexes are also affected by movements in interest rates in the country of the underlying currency and that of the United States’.

Market Vectors and ProShares also have some double long and double short ETNs for investors looking to enhance their exposure. They aim to double the daily performance of a specific currency. Know the risks of short and leveraged funds before you invest, however. They aren’t for everyone.

Barclays’ iPath currency ETNs measure the relative values of two currencies. In the EUR/USD fund, for example, when the euro rises against the U.S. dollar, the fund increases, and vice versa. The provider also has a currency carry ETN, iPath Optimized Currency Carry (ICI), that seeks to capture the returns potentially available from a carry trade. The pool of currencies the index may apply its strategies are known as the “G10″ currencies, which includes the U.S. dollar, euro, Japanese yen, Canadian dollar and Swiss franc.

How to Choose

At this point, there are enough ETNs and ETFs targeting currencies that investors have a whole range of choices when it comes to figuring out how they want to play them. When choosing currency ETFs, consider the differences between the available funds, how they access currencies and their tax treatment. In short, know what you own.

Perhaps one of the easiest ways is via a broad basket of currencies, which help spread out the risk and lessen the blows a volatile stock market can deliver. Some examples:

• Barclays Global Emerging Market Strategy [GEMS] Asia 8 Index ETN (AYT)
• Barclay’s iPath Optimized Currency Carry Exchange Traded Note (ICI)
• PowerShares DB G10 Currency Harvest Fund (DBV)
• WisdomTree Dreyfus Emerging Currency Fund (CEW)

There are a number of single-currency funds available, as well, along with a number of others that are in registration:

• PowerShares DB US Dollar Bullish Fund (UUP)
• PowerShares DB US Dollar Bearish Fund (UDN)
• CurrencyShares Australian Dollar Trust (FXA)
• WisdomTree Dreyfus Brazilian Real Fund ETF (BZF)
• CurrencyShares British Pound Sterling Trust (FXB)
• iPath GBP/USD Exchange Rate ETN (GBB)
• CurrencyShares Canadian Dollar Trust (FXC)
• Market Vectors – Chinese Renminbi/USD ETN (CNY)
• WisdomTree Dreyfus Chinese Yuan Fund ETF (CYB)
• CurrencyShares Euro Trust (FXE)
• iPath EUR/USD Exchange Rate ETN (ERO)
• WisdomTree Dreyfus Euro Fund ETF (EU)
• Market Vectors – Indian Rupee/USD ETN (INR)
• WisdomTree Dreyfus Indian Rupee Fund (ICN)
• CurrencyShares Japanese Yen Trust (FXY)
• iPath JPY/USD Exchange Rate ETN (JYN)
• WisdomTree Dreyfus Japanese Yen Fund ETF (JYF)
  
• CurrencyShares Mexican Peso Trust (FXM)
• CurrencyShares Russian Ruble Trust (XRU)
• CurrencyShares Swedish Krona Trust (FXS)
• CurrencyShares Swiss Franc Trust (FXF)
  

There are also leveraged funds, which enable investors to maximize the movements of a particular currency. The following funds all double exposure by 200%:

• ProShares Ultra Yen ETF (YCL)
• ProShares UltraShort Yen ETF (YCS)
• ProShares Ultra Euro ETF (ULE)
• ProShares UltraShort Euro ETF (EUO)
• Market Vectors Double Long Euro ETN (URR)
• Market Vectors Double Short Euro ETN (DRR)

In registration include CurrencyShares for Hong Kong, Singapore and South Africa, as well as WisdomTree funds for the Czech koruna, Chilean peso, Israeli Shekel, the Russian ruble and many more.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

For more stories on currencies, visit our currency ETF category. For more special reports, view our special report page.

The yen carry trade consisted of borrowing currencies from low interest rate countries like Japan and investing in higher-interest rate countries like New Zealand and Australia. Gary Gordon for ETF Expert reports that during the credit crisis, the yen strengthened by far as Australian dollars and New Zealand dollars declined rapidly. Borrowers had to quickly repay those borrowed yen loans to avoid further losses, further strengthening the yen in a self-fulfilling prophecy-like fashion.

As of late, the Japanese yen ETF has pulled back sharply and is 7.6% off its high reached last December.

Many wonder if the risk-taking has resumed once again among investors. Those who look ahead may assume that the U.S. dollar may resume a downward trend at a time when neither the United States nor Japan will be in a position to raise interest rates. Meanwhile, Australia, New Zealand, Norway… even the European Monetary Union might be in a better position to do so.

• PowerShares DB G-10 Currency Harvest (DBV): up 4% year-to-date

• CurrencyShares Japanese Yen Trust (FXY): down 4.3% year-to-date

• If you believe the yen will continue to depreciate, there’s the ProShares UltraShort Yen (YCS).

Read the disclosure, as Tom Lydon is a member of the board of Rydex Funds.

So far in 2009, the U.S. dollar (to the surprise of many) and gold have reigned supreme, with investors flocking to them as safe havens during these tough economic times.

Gary Gordon for ETF Expert says that the Japanese yen, however, is down more than 10% since it peaked mid-December of last year; the yen has actually fallen below the levels seen at the height of credit anxiety during the October and November low points.

The Japanese yen used to be associated with risk aversion, and now it appears to be struggling. The answer for why is in the hands of the locals; The global recession and the strengthening of Japan’s currency has made it terribly difficult for its multinationals to sell products to the world. And Japan’s famous frugality is further weighing on the economy. The weaker the yen is, the better Japan’s exports do. The leaders in Japan have been purposely weakening the yen.

So far, though, the weakening yen hasn’t resulted in a boom for the iShares MSCI Japan (EWJ), which itself is down 13.5% in the last month. But this could be because investors remain spooked by the health of Japan’s largest companies and the overall economy.

Today, the yen fell to a three-month low against the dollar. The economy in Japan is reliant upon exporting goods such as cars and flat-screen panel televisions. Much of the fear is from the Japanese themselves – they’re taking their currency overseas and spending it, reports Scott Tong for Marketplace.

• CurrencyShares Japanese Yen Trust (FXY): down 2.3% over three months; down 3.8% in the last week

• iShares MSCI Japan Index (EWJ) down 13.6% over three months; down 5.5% over one week

Recently, Japan’s government announced unemployment grew from 3.9 to 4.4 percent, a surprise for a country that formerly enjoyed near full employment, reports Frank Ahrens for The Washington Post. After reports from leading industries, it is likely that further employment cuts are on the way as global consumption plummets.

In November, factory production dropped 9.6%, the largest fall since statistics were tracked starting from 1953. Nations that are in recessions are no longer buying up the nifty TVs, audio equipment, chips, etc. that Japan is known for. Japan is the world’s second-largest exporter. Panasonic plans to cut 5% of its workforce, half in Japan and half overseas.

The Japanese yen remains strong but this means prices for its overseas products are increasing, which consequently reduces demand.

Japanese bank strategists see no sign of hitting rock bottom and admitted that recovery may be quite elusive, but Japan has already taken steps to mitigate the situation.

• iShares MSCI Japan Index (EWJ): down 2.6% in the last week; down 10.8% in the last month

• CurrencyShares Japanese Yen Trust (FXY): down 0.2% in the last week; up 3.6% in the last month

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

This can be witnessed through the so-called Big-Mac Index. The index is based on the idea of purchasing-power parity, which says currencies should trade at the rate that makes the price of goods the same in each country, reports The Economist.

If the price of a Big Mac translated into dollars is above $3.54, its cost in America, the currency is dear; if it is below that benchmark, it is cheap. So far, the yen has gained fair ground, the pound is looking stronger than last Summer, and the euro is over-valued, but less than last smmer.

The Japanese yen is holding strong to a 13-and-a-half-year peak hit against the dollar and a seven-year high versus the euro the previous day. The strength is rooted from investors uncertainty about the global banking crisis. The British sterling held right above its 23-year low against the U.S. dollar, without making any gains, reports Shinichi Saoshiro for Forbes.

Is the road to depreciation ending for the Russian ruble? The quick and sharp downturn of this currency caught many by surprise. Senior officials have suggested that the Russian ruble may be coming back on the road to health, as the currency rallied for a third day in a row as of Thursday, reports Vidya Ram for Forbes.

This short-term rally is spurred by the temporary increase in demand for the ruble because of an upcoming VAT payment day. Corporates for whom payment is due on this date had expected the currency to depreciate,  so they had not been keen to convert their dollar deposits until now.

• CurrencyShares Russian Ruble Trust (XRU): down 8.6% year-to-date

• CurrencyShares Japanese Yen Trust (FXY): up 1.2% year-to-date

• PowerShares DB US Dollar Index Bullish (UUP): up 5% year-to-date

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

Now that 2009 is off and rolling, many strategists have thrown in their two cents on what is going to happen with the markets, stocks and exchange traded funds (ETFs).

• In anticipation of a market rebound during the second half of 2009, the S&P 500 will rise to the $1,200 mark, the SPDR S&P 500 (SPY) is a possible play.

• As paper value decreases and the demand for precious metals increases, gold will jump to $1,200, SPDR Gold Shares (GLD) would be a good option.

• A jump in commodities sending oil to $80/barrel and natural gas to $9/mcf; United States Oil (USO) and Vanguard Energy ETF (VDE) are possible plays.

• The dollar plummets due to low Treasury interest rates, huge borrowing by the Treasury and continuous printing of money. As a result the yen goes to $0.75 and the Euro to $1.69; CurrencyShares Japanese Yen Trust (FXY) is one to watch.

• The 10-year U.S. Treasury Yield climbs to 4% on inflationary worries iShares Lehman 7-10 Year Treasury (IEF) could be influenced.

• China’s growth jumps to 7%, revamping their economy, iShares FTSE/Xinhua 25 Index (FXI).

• Falling tax revenues from the financial sector threaten to bankrupt the State of New York and corresponding municipalities.

• Housing prices stabilize, Obama’s stimulus plan sends third and fourth quarter real GDP in the positive, Dow Jones US Real Estate (IYR).

• U.S. savings rates diminish, consumer confidence is regained and 2009 sees the best Christmas ever, Retail HOLDRs (RTH) would benefit from this.

• Obama softens his bring the troops home slogan and threat of terrorism forces U.S. to keep strong presence in the Middle East, Dow Jones US Aerospace & Defense(ITA) would be a good option.

The mentioned surprises are all speculation, and on the tone of a broken record, no one can read through the all-mighty crystal ball. Always be cautious and do your research when choosing an investment option.