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Any business involved in importing or exporting products or services needs to understand their foreign exchange risk and to ensure they are managed effectively. Even those businesses that aren’t trading internationally are affected by the value of the currency in some way whether through the price of petrol or the cost of a new company car.
There are a few methods to analyse and forecast the behavior of the foreign exchange market with both having the same goal of trying to predict a price or movement in price.
One method is ‘Fundamental Analysis’ which includes such theories as the purchasing power parity (PPP) theory which suggests exchange rates between countries are determined by the relative prices of a similar basket of goods. A well known example of PPP is the Big Mac Index. This is the exchange rate that would mean a hamburger costs the same in America as it does abroad. Comparing actual exchange rates with the PPP would indicate whether a currency is under or over bought.
On the other hand ‘Technical Analysis’ can be broken down into a few principles such as, price reflects all information known to the market, prices move in trends and history repeats. To interpret the charts there are theories that include moving averages, gaps, waves and various forms of indicators.
Well, a new one I received from a friend last week to go along with those charting techniques and one you might like to also add to your toolkit – The Bill English Inverse Indicator.
While the kiwi was down in the low 0.5000s he was asked how low he thought it could go ….0.4000 was likely. Instead from here it lifted to above 0.6000. While it was trading in the mid 0.6000 ….this level is not in line with fundamentals. The kiwi rocketed to above 0.7000.
As from a week ago he is now relaxed about the high dollar. Should you be buying that overseas currency for next year’s holiday? To be fair forecasting the currency movement is not Bills day job (of which I think he is doing great). In fact most of those who do have it for a day job don’t really know which way it will go.
How do those out there deal with this risk, ignore? Pass through pricing? Hedge?
By the way, the kiwi is off several % since a week ago.
12:56, 02.11.2009
I was at a Forex session a few weeks ago with Bill and he got hammered pretty hard.
The NZ dollar is a boutique currency that gets traded heavily. I heard 250 times more than our normal trading would require.
One idea that made sense to me was a (say 1%) levy on FX transactions that were obviously just for speculation – like trades that are reversed a few days later. Not sure if that would work in practice. Any other thoughts?
16:20, 03.11.2009
Not too keen on a levy – it would become too hard for Banks to know what was speculative and what was a “real” exposure. My advice to clients as the dollar sit at between 70 and 72 is to cover forward at least 60% or at most 80% of budgeted 2010 sales (particularly seasonal products). This is if the product based on best kowledge returns shows an acceptable return at that level.The leeway can be used for not meeting budget or a small speculation. We haven’t seen it anywhere near 70 us cents for some time.
11:09, 05.11.2009
In my view “speculative” anything (read based on conjecture or incomplete facts or information) carries risk that by its very nature that the participant is either not informed or accepts there is a parameter of risk in what they are doing. If one is partaking in accepted and understood risk, then go ahead. If one is uninformed and unsure, speculation in currencies is not advised. I have heard a fund manager refer to predicting foreign exchange is like getting a monkey to flick a coin.
Any industry involved in foreign transitions is void of basic planning principles if they do not address this. Most (if not all) major company’s hedge to some level to my knowledge. It may not be 100%, but the risk parameters is understood and a calculated risk (read not speculative) decision is made.
If we want to be in a fee market and a global economy, then variation of our currency is central to this. As long as we remain in a small economy with our own currency, this will vary in value and as Rod rightly states, it remains a Boutique asset on foreign portfolio’s. The only sure thing about the NZD is volatility.
Personal speculation does not affect our currency (read no levy), but major fund managers overseas do. We can’t regulate or levy them or then the “risk premium” of our currency is voided and therefore this stifles foreign investment.
My answer is Hedge to a plan and seek advice.