A reader recently asked my opinion on foreign exchange (forex). It depends, really. Banking on short-term fluctuations or active trading is financial suicide. But as a mechanism for parking a portion of one's excess cash not needed in the medium term (6 months to a year) it's not a bad idea and I actually encourage it.

Short Term Speculation

Anyone engaged in day trading or active trading in forex is losing money, necessarily. Forex is a zero-sum game for investors -- one side must lose in order for another one to win. But there's more: spreads, taxes, and commissions make it necessarily a losing game.

Not only that, but foreign exchange rates are thought to be even harder to predict than short-term stock movements. If you thought it was hard to value a company, imagine a country or a group of countries as is the case with the Euro. There's just too much going on -- policy setting, politics, lobbying, international interference, international trades, changing laws and even wars and natural disasters.

Stay away from short-term speculation on forex.

Medium-term cash parking

If you have excess cash (and you should, for your emergency funds), then diversifying away from your local currency is like buying insurance against three things:

  1. Government actions (jurisdictional diversification)
  2. Inflation
  3. Major catastrophes (natural or man-made)

Government action protection only works if you pick currencies from countries with a reasonable political history. It protects you from arbitrary actions taken by a governments that could adversely affect the currency, such as import taxes, interest rates, or even outright confiscation.

Inflation is listed again separately from government action because it's such a common threat. It's the invisible tax. A basket of currencies can help mask the effect of a single inflationary country devaluing your hard-earned cash.

And of course, if something terrible happens to a country, having some exposure to other currencies can mitigate some of the negative effects.

I currently don't put a lot of faith in the US dollar, so I believe it makes sense to have some exposure to other currencies (gold was discussed here).

Guidelines for investing in foreign currencies

So, what do I recommend? First, when possible, tilt your allocation towards currencies that earn some real (after inflation) yields. The Swiss Franc right now yields 0%, while the Australian dollar yields over 3%. You might as well get paid to wait.

Second, pick countries with a history of maintaining their stability and buying power. In this case, the Swiss Franc is a good option and it is also partially-backed by gold.

Third, choosing currencies whose countries have lots of varied natural resources may provide some comfort about the currency's attractiveness in international markets. Some options that come to mind are Australia, Canada, Brazil and South Africa.

Current opportunities

My current cash diversification is pretty bad and I don't recommend anyone follow it. Given what I just wrote, I will follow my own advice and diversify further. But just because you asked, my cash reserves are currently split as follows: 12% in Brazilian Reais, 6% in Australian Dollars, 4% in Canadian Dollars and another 4% in the South African Rand. The other 74% are still shamelessly in US dollars (in my defense though, I do have international stocks traded directly in foreign stock exchanges in their native currencies).

Until recently I was recommending CDs backed by a basket of foreign currencies, but I found that option to be cumbersome and not very fee-friendly or transparent so now I'm sticking with currency ETFs such as FXA or direct investment in the target countries (to take to the extreme the jurisdictional diversification).

FXA, by the way, is down 3% from last year's averages and yielding more than 3%.

Disclosures: Long FXA.

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A friend brought to my attention a very interesting article by blogger Leo Babauta, of Zen Habits titled "How Not to Hurry".

In the article, Leo exposes the benefits of taking life slower and doing things with more quality, more time and in a more relaxed manner. After all, being productive is not a function of how many things we do at once, but of how many things we complete orderly. "Nature doesn't hurry", says Lao Tzu, "yet everything is accomplished".

That got me thinking about how I practice stock-picking and how any form of investing should be taken: just as lazily, if not more.

Slow to buy, slower to sell

One should be slow to buy. A stock or bond purchase can be planned sometimes for years. Warren Buffett admits having wanted to buy Coca-cola for the better part of his adult life. But it wasn't until 1988 that he got the opportunity. Of course, when the opportunity arose, he was fast to pull the trigger. But being fast in 1988 pales in comparison with his 20+ years of waiting to buy.

Likewise, when selling, one should not hurry either, despite what most "common sense" out there might be. A quick sale would only make your slow buy seem contrived and ill-timed. If you spent time studying what to buy and when to buy it, it makes no sense to turnaround and sell it for a small profit or just because things deteriorated a bit. Most good buys never deteriorate this fast. The kinds of company that are associated with financial scandals and overnight bankruptcies are those you will avoid by buying slow and having a plan.

So, no need to sell anything fast. The slower you sell, the more dividends you collect and the better your tax rates will be.

The zen plan in action

Here is my zen plan that has been working for quite some time (since mid 2008 or thereabouts) with no change and close to zero effort. (Prior to this zen plan I had a somewhat similar strategy that required more effort -- subject for another day.)

  • Make a list. I made a list of good, solid companies that pay dividends and have a history of increasing them (these are also called Dividend Achievers and Dividend Aristocrats).
  • Determine fair value. I worked out their fair value by looking at various metrics, but mostly I valued them as bonds -- how much money will they pay me if they keep on raising dividends at a reasonable clip, comparable to their past history but not faster than growth in EPS and not much faster than their industry. This can be done with the help of the dividend discount model.
  • Apply a discount to fair value. This is to protect from errors in the assumptions. This is the price one should pay for an asset when time comes. Twenty percent sounds reasonable.
  • Wait. I sat and waited. And for a very long time -- a really tedious time -- I didn't buy much, but just waited for my price to be reached. Around November 2008 and then again in March 2009, the market panicked, the financial world was coming to an end and some good stocks traded at or below my target price. That was the time to be fast and hurried and I pulled the trigger many times.

Some of the good stocks I bought then include Gerdau ADR for $4.96 (it's now above $13), Visa for $45.40 (it's now above $80), Pepsi for $47 (it's now approaching $60), 3M several times for an average of $58 (it's now close to $79) and others like PAYX, KFT, HD and KO.

Some of these aren't really dividend achievers, but they all pay a dividend and I had fair prices established for them. (In the name of full disclosure, I also bought GE and a few US banks, which are underwater. I still have faith in GE, and the banks, while anemic, still pay a token dividend.)

Now it's a matter of waiting to collect the dividends and not being in a hurry to sell. If it really leads down the road to riches I will know many years from now.

No hurry.

Disclosures: I own every stock mentioned above plus others that I'm Zenfully holding for the time being.

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I thought it would be time to revisit the NYSE list of short interest. We've last talked about it in April 2009.

The NYSE table is interesting, but as it is it doesn't say much, because it's sorted by absolute number of shares sold short. But companies have different number of shares, so the sheer amounts correspond to vastly different percentages of their total shares.

To put things in perspective I like to look at the percentage of shares sold short, out of the total number of shares issued (column H in the spreadsheet). Too high and it means short sellers are aggressively shorting the stock and are probably very confident about it. Ignore numbers higher than 100%, these are ETFs for which the number of shares issued is simply a matter of market demand for the shares, which are created upon request.

Another interesting metric to look at is the number of days to cover (column G). This takes the number of shares sold short and divides by average daily volume. This tells us how long it would take for short sellers to unwind their positions. The larger the number the riskier it is for a short seller should a stock move against him/her. But it's also interesting from the perspective of a speculator trying to catch a short squeeze.

Finally, I like to combine both days-to-cover and percentage-short in one metric, where the product of the two gives us a number that "combines" both metrics equally. That is, the higher the number the highest the combination of both metrics together where both are equally important. Again, some numbers are skewed due to ETFs going above 100% shares sold short. Disregard those.

Here's the final table. Use it with care.

Disclosures: Long PG, BAC, GE, HD, EEM, KFT, SPY.

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I'm no economist. Neither I have a crystal ball. Nonetheless, all I hear is talk about inflation. I don't know where it is, but from all I've read and thought about, one thing is clear: the US dollar will continue to lose value (as has been the case in the last 40 years or so since coming off of the gold standard), and it is likely to lose value faster than in the last ten years.

Again, I'm no economist. I don't know that there isn't a perfectly acceptable magic way out of this. But economists too have predicted seven of the last three recessions...

Anyway, it doesn't take much understanding about money to figure out that the USD is toast. With 30% of GDP compromised as debt and with the Greenspan-Guidotti rule out-of-the-whack the picture doesn't look rosy for Uncle Sam.

So what's an investor to do?

Well, by and large, nothing much one wouldn't do in normal times: buy undervalued, dividend-paying stocks. In the long run, if anything is going to hold value, it's a well run company with valuable assets (physical or intellectual) with a strong franchise.

Ok, but there might be something else investors can do to tweak their portfolios a bit: they should move their cash away from the USD and bonds and into:

  1. Diversified baskets of foreign currencies
  2. Physical assets (commodities, oil, gold)
  3. More stocks, favoring global companies with business presence in large foreign markets.

TIPS is not an unreasonable option, but being a taxable security and being tied to the official inflation rate (which is computed by those devaluing the currency), I tend to leave them as a distant fourth option.

Foreign currencies

I've discussed the role of foreign currencies before. So I'll just add that there's no reason to completely avoid emerging markets. The Brazilian Real is old news. But the Mexican Peso (FXM) pays a reasonable interest and I don't see it defaulting or going into hyper inflation anytime soon.

Physical assets

My beef with commodities and physical assets in general is their lack of dividends, lack of internal growth rate. Nonetheless, it doesn't hurt to have some as a backup plan.

My favorite commodity would be oil, given its importance as an industrial raw product and its finite production. Also, gold tends to do well in uncertain times like now.

But my favorite physical asset is really real estate. With real estate, one can obtain dividends (rent) and increase its value over time, through proper maintenance, and upgrades.

More stocks

As you may have guessed, investing in businesses is still my favorite option, be them your own business (assuming you're competent and are in a good industry) or someone else's, under the same assumptions, plus the condition that these companies trade for a discount and/or pay juicy, growing dividends.

However, there's no telling what will happen with the US or the USD. If the country defaults, we lose. If we go to war, we lose (as Phillip Fisher said in his book, "War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done") and if do nothing, well, nothing will be resolved.

Disclosures: Long brazilian Real and global real estate.

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Warren Buffett likes to remind us that he likes easy one-foot hurdles he can step over rather than having to jump over the higher ones. He's referring to companies that are easy to understand and provide a lot of downside protection. It's easy to make money if we can find these easy-to-step-over hurdles!

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