What Every Stock Investor Already Knows about Trading Currencies

Today's comment is by Sean Hyman, Currency Director and editor of The Money Trader.

Dear A-Letter Reader,

If you’re used to buying stocks, then you already have some of the knowledge you need to start investing in currencies – whether you know it or not.

Currencies trade on the monstrous foreign exchange market or “forex market.” This dynamite market trades US$3.2 trillion dollars a day, five days a week.

Currencies trade 24 hours a day Sunday evening through Friday evening. So if you hear of some bad news and the stock market is closed, you can still exit your currency position while the stock traders can only bite their nails and wait for the opening Monday morning.

Where You Can Always Find a Bull Market

Best of all, the currency market is 100% bear-market proof. That’s because currencies trade opposite each other (when one goes up, another goes down etc). So currencies are always experiencing a bull market no matter what’s happening in other investment sectors.

In fact, while stocks have plummeted all over the world in the past three months, investors in the Japanese yen, the Swiss franc, the Aussie dollar and other currencies have been cleaning up. These soaring currencies have offset losses from their favorite blue-chip stocks.

The same strategy can work to offset your stock losses. Needless to say, it’s an ideal time to switch over stronger currencies – especially with the S&P 500 dropping 10% just since the beginning of the year.

So let’s take a look at how you can use your stock knowledge to give you a “leg up” in the currency market.

Why the Nikkei Must Go Down
When the Yen Goes Up

If you’ve ever invested in Japanese stocks, then you’re probably familiar with the Nikkei 225 Japanese stock index. And if you already know the Nikkei, then you’re already familiar with the Japanese yen.

Once you’re familiar with the Nikkei, you just need to know that the USD/JPY currency pair mimics this index. When the Nikkei 225 goes down, then the USD/JPY (U.S. dollar vs. the Japanese yen) currency pair also goes down. (When the USD/JPY pair goes down, it means that the dollar is dropping in value in relation to the yen.)

In recent years, the Nikkei 225 index suffers from a weakening dollar and strong yen, because the index is full of exporters like Toyota, Canon, Sony, etc. These exporters prosper the most when the yen is falling and their goods appear cheap, especially to U.S. dollar-spending consumers. The opposite is also true: The U.S. dollar and Nikkei 225 both go up when the yen falls. This causes a “mimicking effect” between these two.

You can see this phenomenon on two charts below.

USD/JPY and the Nikkei 225 Stock Index
Follow the Same Path

This doesn’t just happen for the Nikkei 225 index. If you’re a U.S. investor, I’m sure you’ve watched the Dow at some point. And the Dow Jones Industrial Average mimics a different trade in the currency markets: the EUR/JPY (the euro vs. the Japanese yen). Check out the chart below and you’ll see how closely they influence one another.

The EUR/JPY pair and the Dow Also
Look Like Twin Graphs

Now why on earth do these two follow each other? Well, 10 or 12 years ago, the 30 Dow stocks gained most of their earnings from U.S. consumers. But now things have changed. Globalization has set in. The companies that make up the Dow have expanded overseas. Now these companies draw more than 50% of their income from consumers abroad.

As the dollar falls, the Dow companies’ foreign earnings get a boost just from the currency appreciation. For example, a company may earn euros abroad, but then they have to convert these euro earnings back to dollars on their balance sheets. A weak dollar means that fewer euros equal more dollars on the balance sheets. That makes it look like these dollar-based companies are earning more.

So a declining dollar boosts both the Dow and the euro at the same time. The yen in that trade is basically just a measuring stick to measure risk around the world. When stock risks are high, the yen rallies. When markets become stable and profitable, the yen sells off.

When there’s a stock market decline it naturally causes the yen to rise up against the euro. That brings down the EUR/JPY pair as the Dow and other indices around the world crumble.

So you can see that just by “having a feel” for a couple of stock indexes, you have a real “knack” for knowing where these two common currency pairs are going.

These are just two examples. If you’re interested in just buying currencies (either in an ETF or a CD), you should know:

• The Australian dollar tracks the price of gold
• The Canadian dollar loosely tracks the price of oil
• The Japanese yen is considered a “safe haven” currency when stocks are falling

Keep in mind that these various relationships ARE NOT carved in stone. In fact, not all of these “inter-market” have worked in the past, and they may not necessarily perform as well in the future as they have in the recent past. But these are good rules-of-thumb to follow that can help you switch over to currency market trading. Once you do, I think you’ll find it’s a superior market in many ways. I know I did.

SEAN HYMAN, Currency Director

EDITOR’S NOTE: For more on how to trade specific currency pairs, check out Sean’s currency trading service, The Money Trader. Several times a week, Sean sends out timely foreign exchange trades that let you profit from the biggest moves in currencies all around the world – even while the stock markets continue to bleed. Click here to try out his service, risk free.

With Nothing More than a Cup of Coffee in One Hand, and a Morning Newspaper in the Other, You Could be Making Some Serious Money...

The Fed is Still Desperately Trying to Plug the Holes in the Credit Markets

In another salvo aimed at arresting the strained mortgage-backed market, the Federal Reserve and its overseas central bank buddies are once again trying to breathe life back into the U.S. financial system.

Despite numerous money-market operations since last August, the Fed and other central banks have largely failed to calm credit markets. Outside of Treasury bonds, the entire fixed-income sector continues to bleed. And it’s spreading to mortgage rates.

Last Tuesday’s US$200 billion dollar injection is aimed at the hemorrhaging mortgage-backed market. That’s where liquidity remains the tightest despite the fact that central bank aggressively cuts interest rates. The Fed is effectively trying to put downward pressure on mortgage rates, which continue to rise in 2008. The US$200 billion injection will act as a Federal collateralized loan to dealers, who are desperately trying to unload the distressed securities.

Fannie Mae (NYSE-FNM) and Freddie Mac (NYSE-FRE), the two quasi-government-backed agencies, saw their respective stock prices surge on Tuesday. It seems profit taking has returned to the markets. Apparently, investors are starting to realize that the Fed’s actions won’t provide the quick fix they were hoping for.

Going forward, the Fed and other foreign central banks will continue to plug the holes in the U.S. financial system until they successfully thwart this credit crunch.

The problem, however, is massive spreading from one facet of credit markets to the next. This contagion is preventing policymakers from effectively focusing on one specific blow-up. Instead, central bankers from here to Europe set out on a wild goose-chase every time one distressed area of the yield curve stresses.

It seems each week there’s a new undiscovered acronym threatening the markets. We’re also learning that most banks still don’t have a handle on what these illiquid securities are worth.

In short: The credit crisis lingers. Make sure you hold only government designated money-market funds or short-term Treasury bonds and bills. The bear market is not over for stocks, and it still has a long way to go for credit.

ERIC ROSEMAN, Investment Director

Kellogg Brown & Root Saves Taxes Offshore…
and so Can You

Tax havens are once again in the news.

Allegedly the nation's largest Iraq war contractor "evaded" hundreds of millions of dollars in federal Medicare and Social Security taxes. The company in question, Kellogg Brown & Root (KB&R), avoided these taxes by hiring workers through companies based in the Cayman Islands.

That's led career politicians like former presidential candidate Sen. John Kerry (D-Mass.) to attack the practice. Kerry accuses KB&R and other U.S. companies operating overseas businesses through offshore subsidiaries of "corporate greed." Kerry (along with presidential candidate Barrack Obama) has introduced legislation to close this "loophole."

Excuse me, Senator. This is no loophole. Virtually every other country in the world has the same policy. They quite properly and logically exempt businesses operating outside their borders, which use employees working outside their borders, from withholding taxes on their employees’ income.

It escapes me why it outrages anyone that a company doing business outside the United States can legally avoid paying U.S. tax. What's wrong with KB&R organizing its affairs in such a way as to avoid paying U.S. taxes on its non-U.S. operations? If there's greed involved, it's in the minds of career politicians like Sen. Kerry.

Under current U.S. law, even a one-person company can pull off the same strategy as KK&R. All you need to do is live and work outside the United States, form an offshore company, and pay yourself a salary from that country.

Here's how it works. Companies that are chartered by any U.S. state must generally withhold federal Medicare and Social Security taxes on their employees, anywhere in the world. The exceptions exist by virtue of "totalization agreements" the United States has signed with about 20 countries.

But if a U.S. taxpayer forms a non-U.S. company and pay wages to employees outside the United States, there's no obligation to withhold any U.S. tax to the employees. That's true even if the employees are U.S. citizens.

This only makes sense, because the foreign company will usually be required to withhold tax payments in the foreign countries in which it's operating. It's only fair that the U.S. Treasury maintains a hands-off attitude.

An added bonus: under the "foreign earned income exclusion," the first US$85,700 in wages you pay yourself are legally exempt from U.S. income tax. If you're married, and your spouse accompanies you offshore, both of you enjoy this exclusion. That’s a total of US$171,400/year in wages, completely free of all U.S. tax obligations.

My book The Lifeboat Strategy covers this completely legal tax avoidance tactic in depth. Click here to learn more about it.

MARK NESTMANN, Privacy Expert
& President of The Nestmann Group
www.nestmann.com

Introducing the foreign country...

I'll give you a hint...it's not Switzerland. It's not Panama. It's not even Liechtenstein.

But this country's bankers have steadily and quietly maintained their clients' financial privacy for the more than half a century!

And those "in the know" don't even think of this country as an "offshore haven."

So it's the last place private investigators, contingency lawyers or nosy relatives will look for your wealth.

Click here to learn more about this fascinating country.