The Japanese yen is surging again, thanks to the unwinding of the “carry trade.” (The carry trade involves borrowing cheap yen and investing the proceeds in other currencies.) This surge is bad news for various hedge funds and investment banks, many of which are heavily short yen.
A surging yen is also bad news for Japanese stocks. When the yen rises sharply, the profits of Japanese exporters usually fall. As a result, 2007 was the worst year for the Nikkei index in five years. But Japanese stocks now look extremely cheap -- and the bad news may already be priced in.
On the bright side, Japanese company dividends have risen 25% year on year (with potential to rise further); the price-to-book-value ratio for Japanese stocks is far below the global average; and deep-pocketed sovereign wealth funds could soon be plowing billions into Japanese shares.
The situation offers two ways to profit: A simple move would be purchasing long-dated call options on FXY, the Japanese yen currency ETF, and then buying shares in EWJ, the iShares Japan ETF.
If the yen continues to rise -- or explodes violently higher, as it did in 1998 -- the FXY call options could gain sharply in value. If the yen stalls, however, EWJ could benefit, as value investors swoop down on Japanese stocks.
Profitably Yours,
Justice Litle
Editorial Director, Taipan Publishing Group
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