Diversification is Important

The short-term trend of the U.S. dollar (USD) continues to trade with a downside bias against both the Yen and Euro. Against the Canadian dollar, the USD has rebounded somewhat but remains at near a 20-year low. While the USD has shown some recent buying as U.S. interest rates rise, I continue to be somewhat neutral against the USD going forward.

 The U.S. deficit has been swinging higher. President Bush has a massive $2.77 trillion budget plan that includes higher expenditures for the war against terrorism.

 The problem, of course, is the significant spending is at a time when the budget deficit is expected to touch about $377 billion this year. And despite reassurances from the White House to reduce the deficit over the next five years to about half of the current deficit by the time Bush leaves office in 2009, pundits feel that extending tax cuts will push the deficit to over $1 trillion from 2012 to 2016.

 The rising budget deficit could inevitably lead to a weaker USD as the demand for US-denominated assets decline. For investors, this means holding U.S. stocks may produce added risk should the USD begin to falter going forward.

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 The key is to minimize the risk. You could do this by holding some foreign investable assets. For example, those of you holding investments in Canadian stocks have benefited. The main TSX index in Canada, despite recent weakness, continues to benefit from buying in the energy and gold sectors, a key component of the TSX.

 In addition, the Canadian dollar has done well against the USD since January 2003. In the last two years, the Canadian dollar has climbed steadily from USD$0.65 to over USD$0.90 recently. By holding Canadian assets, you would have made a nice profit from the rising Canadian dollar.

 Geographically, you could also invest in such places as Japan, India and South Korea, all of which have had some strong market gains over the last few years. In these countries, I would look at stock mutual funds or Exchange Traded Funds (ETF) as a safer strategy than buying individual stocks or ADRs.

 Another way of hedging against a decline in the USD is to buy foreign bonds denominated in other currencies. Canada is an ideal place for good quality bonds.

 So however you do it, diversification is an important strategy for your portfolio. If the USD begins to trend lower, you need to be have some assets denominated in other currencies.