Currency Cache

Merk Hard Currency (MERKX) turned in a bullish performance for much of 2008, flying high until about the middle of the year. At that point it looked as though the global economy would fall into a deflationary spiral. Although there are still lingering concerns about the state of the global economy, conditions seem ripe for a solid 2009 for the fund.

The fund invests–as the name implies–in “hard currencies.” Management defines hard currencies as either backed by sound monetary policy that engenders price stability or money that’s backed by gold. That leaves the fund with a portfolio made up of SPDR Gold Trust (NYSE: GLD), which accounts for almost 12 percent of assets, and debt instruments issued by foreign governments, primarily European but including Canada, Australia and Japan.

That arrangement will drive the fund’s performance this year despite the current strength the US dollar is enjoying. Before all is said and done, the US government’s stimulus efforts will likely cost more than $1 trillion, and that spending is largely being financed by debt issuance. The Treasury Dept is selling record setting amounts of bonds, and that’s going on in essentially a zero interest rate environment.

There’s little argument over the necessity of the spending program, but it still boils down to the government attempting to inflate the US out of trouble. That combination of factors means that the US dollar will have to be devalued sooner rather than later. And that makes currency plays and gold more attractive by the day.

Gold prices have been steadily gaining in recent weeks as investors have looked for some measure of stability in the face of the long-term ramifications of the proposed stimulus package. And the currencies held by the fund have also been gaining ground as sensible central banks have been recognized for sound monetary policies.

Manager Axel Merk has proven his ability to navigate the currency waters, generating double-digit returns in years of dollar weakness and minimizing losses during periods of a strengthening dollar by moving primarily into gold. All the while, he’s minimizing risk by focusing on debt instruments issued by governments rather than straight currency contracts.

Don’t put all of your eggs in the Merk basket, though; rather, use the fund primarily as a hedging position, particularly if your portfolio is heavy on foreign companies doing business in the US. The US is likely to be the first of the major economies to revive in the wake of this recession, at which point the Federal Reserve won’t be able to drag its feet on raising interest rates. In turn, the dollar should rally quickly.

But that looks likely to be at least a year or more away. In the meantime, Merk Hard Currency should generate nice gains.

Alternatively, you can hold the ultimate bond, gold. While owning bullion itself is the best way to go, it’s rarely practical for individuals. SPDR Gold Trust, which accounts for the lion’s share of Merk’s portfolio, is backed entirely backed by physical gold bullion. You won’t benefit from the currency exposure, but you’ll own the only true hard currency.

WHY TO BUY

MERK HARD CURRENCY (MERKX)

SPDR GOLD TRUST (NYSE: GLD, $89.40)

*Government response to crisis assures future inflation

*Credit markets are improving, but bond prices remain depressed

*Gold rally will likely continue