By Neil George, Editor of The Pay Me Strategy

Contrary to a seemingly endless stream of pitches, the dollar is far from floundering. In fact, if you look at how the dollar is doing so far this year against the two largest alternatives – the euro and the yen — so far it’s either up over 6 percent or at worst near flat respectively.

That isn’t stopping plenty of brokers and gurus from pitching currency investment schemes to folks that remain nervous about the U.S. economy and the general stock and bond markets.

Trading and investing in currencies should really never be about the negatives, but rather the positives. Think of a currency as a stock of a country — in the case of Europe, a stock of a contrived political agreement.

When you’re looking at buying a stock or fund for your portfolio, do you start by trying to look at the worst performers from ailing industries? No. Instead, you’ll likely try to discern some part of the market that has some positive prospects and narrow down your decision to an investment that should perform well in the months to come even if things get rocky.

The same should be done with currencies.

Right now, too many folks are trying to focus on what might be going wrong for the U.S. economy including the build-up of government spending and borrowing. Others take a different spin, saying “If the U.S. is cooked, perhaps Europe or Japan might be in better shape.”

The trouble is that if you look at the arguments for a decline for the dollar– rising debt and a lack of fiscal restraint — you’ll find the same problems (if not much worse!) for nations that make up the euro zone as well as for Japan and Canada and plenty of other regions.

So instead of focusing on which currency has the least troubled economy behind it, what are the positives conditions that you can use to pick the right currencies?

It’s All Fundamental

Currencies, just like stocks, will move up or down from changes both in the short term and the long haul.

In the short term, the biggest drivers for change comes down to interest rates and market sentiment. Traders don’t just buy and hold currencies in cash — they generally buy and sell for forward delivery. This means doing a trade today for settlement a week to many months in the future.

Even a bank that offers currency deposits won’t just hold the currency. It will book a CD in another currency, put the dollars into the general deposit liabilities of the bank and then buy a forward contract on the specific currency to the date of the CD’s maturity to create the synthetic currency deposit.

Currencies tend to have differences in interest rates. The result is that a currency being bought with a higher rate than what’s being sold will be a better forward price for the trade. Consequently, if a currency being bought has a lower rate than the one being sold, the forward price will be more costly. This equalizes the carry or yield for both sides.

As interest rates go up or down, forward prices move up or down. Giving traders or even a bank hedging its exposures profits on the currencies’ with rising rates or losses on currencies with rate cuts.

This is the core underlying moving factor for currency trades. And yes, sentiment changes from political or economic announcements will move currencies — but the big driver is always rate differences and changes.

Longer term, it really comes down to capital flows. More cash going in or out of either commercial or investment accounts across borders. More imports or exports or more demand for stocks, bonds and direct investment will result in underlying currency buys or sells to settle everything up.

And for the dollar, you have to note that it’s not just the currency of the U.S. but the currency of markets in many countries around the world. So even if our exports sag, others using the dollar can generate continuing demand for dollars.

The key then is to pick currencies from markets where there’s not just an interest advantage, but that you’d want to invest into the markets that are thriving.

Short & Long-Term Buys

For the short-term currency plays – look at currencies with rising interest rates. Many of these are Asian-based including India (rupee), China (renminbi), Indonesia (rupiah) and others.

And the markets show this as these currencies have been trading up against the dollar and well as the euro and yen. There are ETFs that attempt to track some of these currencies via forward trades. Wisdom Tree runs some including the Indian rupee fund (ICN) and China renminbi (yuan) fund (CYB).

Note that for the renminbi the Peoples Bank of China (PBC) and China’s SAFE (State Administration of Foreign Exchange) work to limit near-term shifts.

Longer term, investors wanting to cash in on currencies should look to the investments in local countries. This means the stocks and bonds of positive performing economies.

On the stock side for China, look at Bering Asset Management’s China Fund (GCH) trading at a discount of over 16% And for India, Blackstone’s India Fund (IFN) at a 9% discount. For Indonesia, Credit Suisse’s Indonesia Fund (IF) is trading at a 8% discount. All offer a great mix of local market leaders.

For income — bonds can be harder to trade — but look at a well-run closed-end fund that’s proven it knows how to cash in on higher rates and currency moves. AllianceBernstein’s Global High Income Fund (AWF) pays over 8.4% and has an average annual return for the past decade in excess of 13% per year from shorter-term global bonds.

Neil George is editor of The Pay Me Strategy (www.paymestrategy.com).

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