The Wall Street Journal recently reported that currency trading volumes have surpassed $4 trillion per day -- an 18% increase since 2007. What's driving this surge in interest in reais and rupees? According to the Journal, citing a report from the Bank for International Settlements, it's "the increased globalization of investing" as well as a search for higher returns in faster-growing economies and a greater focus on diversification.
While all of that is no doubt true, the explanation misses what I believe is the real driving force here: widespread panic about the dollar.
For evidence of that
As currency trading has been surging, the dollar has been weakening against almost every other major world currency. Over the past five years, the dollar is down against the world's two other reserve currencies, the euro and the Japanese yen, as well as against major emerging market currencies the Chinese yuan and the Brazilian real. In fact, the only currency that has weakened against the dollar over the past five years that's either a reserve currency or has the potential to become a reserve currency is the Indian rupee.
As you can see from that chart, however, this ride has not been without volatility (apart from the steady weakening of the dollar against the Chinese yuan, which is a managed currency). Further, it's against that backdrop that the world has witnessed an incredible rise in the price of gold.
Invert that performance and mash it together with what has happened in the currency world, and what you see is that the purchasing power of a U.S. dollar has declined against almost every other vehicle human beings use to store value.
What this suggests to me is that while investors are skeptical of the dollar, they're also not all that confident in any of their other currency options. For proof of that, take a look at how the dollar has declined more against gold than against other world currencies despite the fact that you can arguably buy more with airline miles than you can with gold.
Clearly, investors have far more confidence in gold today than they do in the fundamentals of the United States, Europe, Japan, China, Brazil, and India. After all, gold, unlike the United States, Europe, and Japan, isn't overleveraged with dim growth prospects. And unlike China, Brazil, and India, gold doesn't have to conquer the problems of cronyism, corruption, insufficient infrastructure, and a widening divide between the rich and the poor.
Given the track records in these countries, that's not necessarily an irrational opinion. That said, while I remain bearish on the dollar, the euro, and the yen, I believe that over the longer term, the emerging world can address the problems facing it today and lead global economic growth over the next decade or longer. If you believe that as well and buy the argument that gold is more currency than commodity, then the variance between the recent performance of gold versus the dollar and emerging market currencies versus the dollar has created an intriguing opportunity.
Here's how that works
That opportunity specifically is to increase your exposure to emerging markets currencies that have the potential over time to more and more resemble reserve currencies as those economies develop and investors continue to decrease exposure to the U.S., Europe, and Japan. As that happens, investors should buy up exposure to China, India, and Brazil -- the three markets that have the most potential given their size and scope to become dominant world economies -- in lieu of buying up more exposure to gold. This isn't to say that gold prices will crash, but rather that the gap between gold and emerging market currencies should narrow over time, with the value of major emerging market currencies likely to strengthen against the dollar over time.
Don't, however, go out and start buying up emerging markets currencies. As the Journal pointed out, currency trading generally involves a great deal of leverage -- a dangerous game in this fast-moving, volatile niche.
Further, this is not a short-term call on emerging markets currencies, but rather a long-term observation that should play out over the next five to 10 years. The play, then, is not to buy currency exchange-traded funds such as the Brazil Real Fund
The Foolish bottom line
Currency trading is a zero sum game. In order for the dollar, euro, and yen to weaken as many expect given the financial and demographic realities in those markets, something else has to get stronger. Gold has thus far picked up the slack in that regard, but I suspect the answer going forward for investors will more and more turn to emerging markets as they get comfortable with the fundamentals in these markets.
That, of course, will take some time given the real challenges these markets face today, but this isn't a short-term play. Rather, it's a long-term megatrend that all investors -- and particularly dollar-heavy investors -- will be rewarded for including in their portfolios.
Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of Philip Morris International. Embotelladora Andina A. and Philip Morris International are Motley Fool Global Gains recommendations. The Fool owns shares of China Mobile and Philip Morris International. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.