Safe Bonds With 7.35% Yield
Date: 05/13/2008Wednesday, May 14, 2008
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The U.S. dollar is now under incredible pressure, and the timing couldn’t be worse. The U.S. economy is also sinking fast. This places the Fed between a rock and a hard place. To support the greenback, the Fed needs to raise U.S. interest rates…but its classic response to the threat of an economic recession is to lower those same rates.
Right now, the lowering strategy is winning, and the lower U.S. dollar interest rate means that investors are likely to park their investments and savings in other currencies that pay higher returns. This reduces demand for dollars and means the dollar may fall even more against other currencies.
This creates the perfect Multi-Currency Sandwich position…an investment strategy that borrows a potentially weak currency at a low interest rate and invests the loan in a potentially strong currency at a higher rate of return.
The troubles of the U.S. dollar are so serious right now that one opportunity—unimaginable in the 1980s and '90s—is to borrow U.S. dollars to invest in Russian rubles!
Russian political stability looks strong with the new president Dmitry Medvedev assuming office. But Russia is facing many economic challenges, especially inflation. One way the Russian central bank will likely solve this is a revaluation of the ruble. This creates the potential for significant gain due to the interest rate differential between the ruble and the dollar…in other words, a “positive carry.”
My banker at Jyske Bank just offered a Bank of Moscow bond issue that matures in 2009. The bond has a coupon of 7.25%, but sells at a slight discount so the yield is 7.35% per annum. Because of falling interest rates in the U.S., Jyske Bank will lend you dollars for 4.5%. This means you make 2.85% positive carry by using Bank of Moscow bonds to borrow dollars.
For example, say that you invest $100,000 in the Bank of Moscow bond mentioned above. You earn $7,350 a year interest. If you use that $100,000 bond as collateral and borrow $200,000, your cost for the loan at 4.5% per annum is $9,000 a year.
You use the borrowed $200,000 to buy Bank of Moscow bonds, increasing your yearly interest income to $14,700, or $5,700 more than the interest cost of your dollar loan.
Now your total return on the $100,000 you originally invested is $13,050. Your Multi-Currency Sandwich has nearly doubled the return on your investment. Plus, since your Bank of Moscow bond is actually bought with and denominated in rubles, you stand to gain on any appreciation of the Russian currency as well. If the ruble appreciates 10%, your Forex gain would be $30,000...a nice bonus.
Fundamental fiscal conditions in the U.S. suggest that the greenback will remain weak. Economic conditions point toward continued low dollar interest rates. However, there is always a risk of reversal of rising interest rates and a stronger dollar versus the currency you invest in. I suggest using this technique only for mid- to long-range investment time frames…five or more years. And never leverage more than you can afford to lose.
Gary Scott
For International Living
Editor’s note: Gary has been dealing with bonds and currencies for almost 40 years. He never worries about the value of the dollar, or the recession as there are always currencies…and companies…that can weather the storm...even prosper...over the long term. To see how you can do this, too, read this special report.
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