Learning to trade more than a few Egyptian pounds

There is increased appetite among investors for alternative plays such as currencies and commodities.

Make sure you know what you are doing before you start hedging currencies.

The most sophisticated currency trade I've ever made took place at the airport several weeks back, after I found a few stray Egyptian pounds stuffed in my pocket while returning from Cairo. I slid the 100 pounds or so under the glass at the currency exchange counter. The man pounded on his calculator for a bit, and he handed me about Dh65. In my world, that qualifies as high finance.

I was thinking of that episode the other day when I had an occasion to sit down with two gentlemen in the business of advising people whose net worth includes several more zeroes than my own. Their overall analysis would likely lift the spirits of regional investors of all sizes. "There is too much gloom and doom" in the markets, proclaimed Giles Keating, the head of global research with Credit Suisse.

Mr Keating, who is based in Zurich, was in Dubai spreading his message that the naysayers are reading the global economy all wrong and that this year would see a "robust" recovery in most asset classes. His colleague Kamran Butt, the Credit Suisse head of Middle East equity research, issued a similarly sunny prognosis for the regional economy, predicting that the UAE will post non-oil GDP growth this year despite the downturn.

But I was struck by Mr Butt's comment when asked what he was hearing most frequently from his wealthy clients. "The theme of diversification is really quite prominent," said Mr Butt. For most retail investors, diversification means building a portfolio with a mix of stocks and bonds, or at least investing in mutual funds instead of only individual stocks (there remain those who consider themselves fully diversified if they charge evenly among their Visa and MasterCard).

Mr Butt, however, was talking about the increased appetite among investors for alternative plays such as currencies and commodities. The numbers bear out the trend: the Dubai Gold and Commodities Exchange (DGCX) in February saw a 146 per cent spike in volumes compared to last year, while the Dubai Mercantile Exchange posted a record level of future contracts outstanding. This is notable, as many local investors have been content to ride the rising tide of oil prices and property values that has lifted almost all boats in the past decade. Now, however, it seems they are pursuing more hedging strategies that could limit the stomach-churning volatility of late.

There are several factors at play. One is that other asset classes are - let's put it charitably - less attractive than they have been in recent years. Local equity markets are sluggish, with depressingly low volumes, and it takes a cast-iron stomach to wade into the property market at the moment. Another is that experts like Mr Keating and Mr Butt see weakness in the US dollar on the horizon. "Our mid-to long-term view remains fundamentally that the dollar will be on a bearish trend," Mr Butt says.

This is especially significant for UAE residents, given that the value of the dirham is pegged to the dollar. As a result, some local investors who think they are adequately diversified "don't always notice the actual currency exposure they have", Mr Butt says. The move to non-dollar-based assets, like commodities and foreign currencies, is their attempt to achieve a better balance. In this region, most savvy investors are familiar with how to trade commodities, particularly oil and gold.

Currencies are another matter. For example, when talking with the Credit Suisse guys, they recommended owning euros and Swiss francs, as well as a selected basket of currencies from emerging markets, including the Brazilian real, Mexican peso and Indonesian rupiah. Fair enough, that sounded perfectly sensible. Still, I walked out wondering if most retail investors are about as experienced in currency trading as I was returning from Cairo.

But after a few conversations with the experts in the field, I identified several relatively straightforward methods of playing the foreign currency market, or forex as those in the know like to call it. Perhaps the easiest is through an exchange-traded fund, or ETF. This is basically a mutual fund that trades like a stock in that its value changes throughout the trading day. For instance, those looking to hedge against the falling dollar might want to look at the Powershares US Dollar Index Bearish Fund, which "shorts" the dollar by trading in the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. Another option is to find a broker who listed on the DGCX, of which there are more than 140.

The obvious allure is that you benefit from the advice of a professional who actively monitors the forex market on a daily basis. "If you are not that sophisticated, you should be working very closely with a broker," Eric Hasham, the chief executive of the Dubai Gold and Commodities Exchange, told me. One potential pitfall of working with a broker is the cost involved, as most will charge fees for each transaction (most ETFs, by comparison, charge minimal fees).

Mr Hasham says brokers will establish an online account for experienced currency traders capable of identifying and executing trades on their own. The average investor should stick with an account that requires the broker to place the trade on the client's behalf, providing a safeguard against pursuing a trade without the client understanding the risk involved. About 90 per cent of brokers registered with DGCX are based in Dubai, but some have branch offices in Abu Dhabi.

A third option is a so-called structured product. This is basically a custom-designed vehicle developed by a bank to achieve a specific goal such as, to name the relevant example, hedging against the dollar. As Mr Butt noted, these investments have garnered a fair share of bad publicity in recent years, largely because some that were sold as practically risk-free imploded in the bear market. But Mr Butt says a well-designed structured product remains the most effective way to participate in the upside of a currency strategy and still protect against losses if the expected trend does not materialise. These vehicles are often available only to high-end investors with minimums of tens of thousands of dollars.

Overall, Mr Hasham's advice is sound, that it is "highly important that investors understand the product they are trading and the risk of the environment they are trading in". That brings me to a final option: stick with hard currency. If you're angling to diversify, you can always simply take a wad of dirhams or dollars down to the bank or an exchange house and swap it for a currency that you think is better positioned. Should the dollar fall, you could collect a tidy return.

It's a variant on the old "cash under the mattress" investing method - the cash is just of a different colour. [e-mail]