FEB 11 — Here is a question for you: Why is it that many of us are happy to own shares as part of our investment portfolio, tracking prices with our smartphones on a daily basis, yet we have never considered investing in currencies? We pore over news about companies building factories in Brazil or opening offices in Russia, but we are as likely to take exposure to the real or the rouble ourselves as we are to buy real estate on the moon.
If you are one of the millions for whom foreign currencies are simply for holiday spending, you may be surprised to learn that private investors are flocking to the foreign exchange (FX) market in ever-increasing numbers. A recent survey by the Bank of International Settlements (BIS) found that the global FX market now turns over an average US$4 trillion (S$5 trillion) a day, 20 per cent more than in 2007. The BIS identified "significant" growth in cash or spot trading by retail investors, with daily activity attributable to households and small non-bank institutions estimated at about US$125 billion to US$150 billion.
Once closed to all but banks and a small group of institutional investors, the FX market has been revolutionised by the Internet. Widespread access to electronic pricing and trade execution services has demystified currencies, attracting people to the world's most liquid asset class and putting downward pressure on dealing costs. Through their brokers, or direct from their homes, investors can trade without fear that news affecting their holdings will break while the stock exchange is shut, or while market-makers in their bonds are tucked up in bed. FX is a truly 24-hour business.
Of course, the Internet has as much power to confuse as it does to illuminate. A quick search will throw up thousands of pages of advice and offers of services, many of which portray currency investment either as pure gambling or as a sure-fire path to easy riches. The reality is that it is certainly not the latter, but it does not have to be the former either if approached in a rational and informed manner.
Approach, but with caution
Like stocks, bonds and commodities, currencies move on news and analysis. Unlike stocks, which move for any number of reasons - from product launches and executive changes to financial announcements and the general direction of the market - currencies are influenced by macro-economics.
Because its volumes are so large, and because it is not controlled by any companies or bourses, the FX market is hard for anyone other than central banks to influence in a significant way. Macro-economic announcements, such as government reports on national GDP growth or inflation, are released to all without favour.
While any investor can trade, we advise our customers to approach the spot market with caution and to apply a diversified medium- or long-term approach to currencies. With lower volatility in the FX market compared to equities, investors tend to use leverage to increase their investment power, resulting in fast profits or sudden losses. Even professional investors get caught out, as many were last year by surprise central bank interventions in countries as far apart as Switzerland and South Africa.
Since every FX transaction involves a pair of currencies - e.g. from dollars to yen - it is important to have knowledge of the economic outlook at both ends of the trade; in this case the US and Japan. To quote an old cliché, knowledge really is power.
A common complaint voiced by spot traders is that with so many variables affecting the cost of money, it is hard to know when to buy a currency and when to sell it. For example, the US may report weak economic data that would logically make the dollar a sell, yet many investors may buy it as a safe haven due to greater concern about economies elsewhere in the world. Another economy might be growing well and yet face unnerving inflationary pressures, dampening demand for its currency since inflation erodes purchasing power.
For those who look beyond the short term, foreign currency deposits and structured investments can potentially deliver gains in the event of appreciation in the value of the target currency and from higher relative interest rates. Some currency-linked products may offer capital protection in return for specified time commitments.
Consider the yuan
Perhaps one of the greatest opportunities in the FX market today comes from the Chinese yuan, which has appreciated by about 24 per cent against the US dollar since 2005. As Beijing relaxes controls over the yuan, we have seen significant demand for currency deposits from investors who believe, as we do, that China will sustain economic growth in excess of 8 per cent annually through 2013. Though, as with any currency, there is no guarantee of appreciation, we forecast the yuan will rise by 3 to 5 per cent annually over the next few years as it becomes increasingly popular as a medium for investment and cross-border trade.
Whether you are new to currencies or an experienced investor, the good news is that FX is one of the few "all-weather" markets accessible to retail investors on a 24-hour basis. For some, this will not be enough to persuade them to take the plunge. For others, it is clear the opportunity is already proving too big to ignore. — Today
* Paul Arrowsmith is head of retail banking & wealth management, HSBC Singapore.
* This is the personal opinion of the writer or publication. The Malaysian Insider does not endorse the view unless specified.
