Hedging can help you offset losses caused by dollar fluctuations

The View From Here There's also a fine line between hedging – that is, protecting yourself against risk – and speculation.

As the dollar weakens, the share price of a hedge stock rises concomitantly. Dylan Martinez / Reuters

Over the past year, I have effectively taken a 50 per cent pay cut. This is not because I want to save my employers a few extra dirhams a month - I am sure they are doing quite nicely without my help.

It's the fault of the Americans and their feeble currency. When I first arrived in the UAE, I was getting close to 11.25 South African rand, my home currency, to the dollar. Today, it's about 6.7 rand to the dollar, which means, in effect, I am doing the same work for almost half the cash. Luckily, I am a very altruistic person.

For expatriates earning euros, pounds and Australian dollars, the situation is little better. All these currencies have gained against Uncle Sam's green. Which, of course, is linked to the dirham.

Canadians will get 20 per cent less for their loonies and Australians even less - they take a 30 per cent cut.

Currency fluctuations are the bane of offshore earnings. Good when they work for you, bad when they don't. And it makes planning difficult because you can never count on a steady rate.

Hedging is a strategy you can employ to offset currency losses - either by using exchange-traded funds or directly through buying shares.

The first is to look at stocks of companiesthat report their costs in dollars, but export heavily and so earn a significant amount of their income offshore. Coca-Cola, Phillip Morris, Nike and McDonald's, for instance.

Barry Knapp, a US equity portfolio strategist at Barclays Capital, illustrated this in The Wall Street Journal a week ago. He said that in the fourth quarter of 2003, the dollar fell 5.8 per cent on inflation fears. In response, the large-cap S&P 500 index surged 11.6 per cent. The S&P is heavily weighted to exporters.

Essentially, as the dollar weakens, the share price of a hedge stock rises concomitantly. Analysts will tell you this is because the fundamentals of the company are changing. Each cent the greenback gives up is translated as a cent of profit for a corporation earning profits in pounds, euros or rands.

But for hedge purposes, the fundamentals are not especially important. As long as a company is on the radar of large currency holders, its share price is going to reflect minute intra-day fluctuations of the dollar.

This principle is not just applicable to the greenback. It works with any currency you care to mention. In times of pound weakness, for instance, shares such as BHP Billiton and Rio Tinto will become the choice of currency hedgers.

Because I am South African, my hedge favourites during times of rand weakness have tended to be miners - they pay their way in local currency and sell their produce in dollars.

Gold and platinum are, of course, other hedge favourites. Like oil, the price of gold rises as the dollar weakens. It does this not so much because the underlying commodity is worth more, but because the dollar is worth less.

This may be a small comfort to the citizens of the Home of the Brave, who must now pay 40 per cent more than they did a year ago to fill up their minivans. It's no consolation that the value of the juice they put in their tanks has not changed much in 12 months - it's their wallets that have shrunk.

Big companies know this. And they have hedge strategies to protect themselves from all this unpleasantness. For us little guys, this also works to our advantage. Because the Nikes and United Airlines of the world have to hedge, they are compelled to buy into stocks that will react to currency movements.

The stock of the hedge companies will surely react to the large influx of money running for cover. Investors and speculators will anticipate the movement and pile in as long as the dollar is on the ropes. The performance of these stocks therefore becomes a self-fulfilling prophecy.

Hedging is not without risk. Currency value is notoriously fickle and can quite easily change direction. Recently, silver investors discovered just how fast a commodity - and currency hedge favourite - can switch from a bull to a bear.

There's also a fine line between hedging - that is, protecting yourself against risk - and speculation. Hedging is not, strictly speaking, about making money. It's about keeping the money you have intact.

Gavin du Venage is a business writer and entrepreneur based in South Africa.