February 25, 2011

Forex: A Way to Play the Rise in Food, Energy Prices

The British pound and other currencies are an alternative means of investing, given today’s commodities shocks.

With oil pushing $120 a barrel at times this week, the financial world is rife with talk of energy plays — which competes with agriculture as a top spot for hot.

The price at the pump has already reached as high as $4.51 in California, and the Department of Agriculture on Thursday released its forecast that food prices will increase 3.5% this year.

At higher elevations, revolution and repression in the Mideast, which has its origins in food-price hikes, and is coming back to us with oil price hikes, encapsulates the trend.

But, rather than pile into energy and ag stocks, is there an alternative approach?

Indeed, dramatically rising food and energy costs are almost the definition of inflation. I say almost since, although food and energy are important parts of the basket of goods and services that make up the consumer price index (CPI), they are excluded from “core” inflation, a gauge used to view inflation from a longer-term perspective.

But events and trends in the world seem to suggest the surge in food and energy costs have room for further escalation.

And this will unleash the hawks among monetary authorities worldwide, who were already beginning to gain the upper hand in internal policy meetings.

This monetary connection suggests a foreign-exchange play.

When a central bank raises the rates it charges commercial banks, it strengthens the currency. That is because savers can earn a higher rate of return as depositors — without taking on the higher risks of equity investing.

Forex trading is all about how one currency relates to another. While the trends augur for central bank rate hikes across the board, opportunity lies inarbitraging these currency differences.

For example, while both the U.S. and U.K. have been pursuing an easy money policy throughout the Great Recession, one might reasonably conclude based on the minutes of monetary policy meetings that the commitment to quantitative easing is eroding more speedily in the U.K. than in Bernanke’s Fed.

Britain’s Daily Telegraph editor Jeremy Warner calls a Bank of England rate hike a “done deal.”

Fed chairman Ben Bernanke probably needs a bit more time to set up a rate hike to avoid too great a shock to the economy, given his dovish stance until now. Expect the hints to come soon though. For these reasons, a U.S. dollar-based investment in British pounds would be an alternative way to play the commodities shocks we’re currently experiencing.

Rydex’s Currency Shares British Pound Sterling Trust (FXB) may be the optimal way to gain this exposure. Investors may also want to consider the iShares Pound/Dollar Exchange Rate ETN (GBB).

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