Friday, May 7, 2010

Here is an idea for taking advantage of the recent currency fluctuations.

Even if you have written off the U.S. economy, something that is not wise to do, there are a number of great U.S. companies with a worldwide presence that will likely do better and better over time. Examples include Microsoft, General Electric, Johnson and Johnson.

So you buy them now while they still trade at moderate prices. Let’s for example use Microsoft. This cash generating monster has been shunned by investors for many years and it is so much cheaper than Apple or Google; however successful, you can buy Microsoft still at a modest P/E. If you buy it at the bottom of the current trading range for $27 and just hold it until we’re back to where it was just a few days ago (at $31) you’re bound to make a nice profit.

But now add the currency effect. In times of instability, the Canadian Dollar trades at its lows due to the ‘flight to quality’ as strangely the U.S. dollar is referred to while U.S. debt load keeps piling on. Next thing you know, things were not so bad as all the pundits said. Commodities rise again and everyone runs away from the U.S. dollar , and voila, the Canadian dollar is back at parity and some ‘experts’ predict it may well go as high as $1.05. So why not buy Microsoft with borrowed money?

You buy e.g. 100 shares of Microsoft for around $27.00 U.S. and now you borrow the money from your U.S. margin account, $2700 plus $ 10 buying commission. Now you wait until the $Cdn recovers (say that takes 3 months) or it even shoots up to $1.05 and you pay off your loan which used to be: $2710/0.95 or $2852Cdn. but is now only: $2581 Cdn.

You’ll be paying interest of say 7% per year or $47U.S. for 3 months. After 6 months (or less) all misery is forgotten and Microsoft trades ones again around $31.00. Oops, you also got two dividend payments of 2x100x0.13 = $26 and you sell off the shares. The dollar is down again to 0.95 because this time Iran is making ugly nuclear noises. Your proceeds: $3100 plus $26 minus $10 selling commission and minus 3 months interest ($47) = $3069 U.S. or $3230 Cdn. That is a profit of $649 on Cdn $2581 invested or a return of 25% in 6 months or 50% per year.

There is risk, so don’t overdo it. Microsoft shares could fall after all, or the Canadian dollar does not recover. Also, it means you will have to keep a close eye on both Microsoft and the currencies, but for 50%? Why not! You can play the same game with GE or JNJ or with shares of whatever other great U.S. company you feel comfortable with.

2 comments:

  1. Grat strategy. Let me know if this works out.

    Nick

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  2. Oh, it worked all right. The question is will it work again? There is always risk involved and often the potential returns are highest when the risk is highest.

    That is the topic of a series of upcoming posts. Risk, what is it and how can you manage risk?

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