Not too long ago there was big talk about the euro overtaking the U.S. dollar as the world’s new reserve currency. But ever since then, economic troubles in debt strapped countries like Greece and Portugal have quelled belief the euro is ready for the big time.

While last year was marked by a brutal fall in the U.S. dollar relative to other world currencies, this year has been quite the opposite. The U.S. dollar index has risen since the beginning of the year from 77.86 to around 83.08. The dollar index measures the performance of the greenback against a basket of six foreign currencies.

How can you capitalize on the strengthening U.S. dollar? And is it a short lived phenomenon?

Dollar Investing – Think Domestically
The first way to profit from a rising dollar is to own dollar denominated securities. In addition to providing securities diversification, domestic focused index funds and index ETFs provide direct unhedged exposure to the U.S. dollar. Simply put, U.S. stocks or bonds inside index funds are traded and priced in their native currency, the dollar.

This year’s strengthening dollar versus foreign currencies has helped to lift the value of domestic stocks over foreign stocks. The total U.S. stock market which measures the performance of large, mid and small cap stocks is outperforming its foreign counterparts.

Meanwhile, foreign stocks in developed countries as represented by the iShares MSCI EAFE Index Fund (NYSE: EFA) have underpeformed this year, while emerging market stocks as represented by the Vanguard Emerging Markets ETF (NYSE: VWO) are flat. Currency weakness is putting a damper on the performance of foreign securities, particularly Europe investments as represented by the Vanguard European ETF (NYSE: VGK).

Going Inverse With ETFs

A second way to profit from a rising dollar is to bet against foreign securities. Inverse or opposite performing funds/ETFs are designed to increase in value when the securities they’re benchmarked against decline. Some inverse funds/ETFs attempt to magnify their gains with 2x or 3x daily leverage.

For funds that short foreign stocks with 3x daily leverage see ticker symbols Direxion Daily Developed Markets Bear 3x Shares ETF (NYSE: DPK) and Direxion Daily Emerging Markets Bear 3x Shares (NYSE: EDZ). Funds that use 2x inverse daily leverage are ProShares UltraShort MSCI EAFE Fund (NYSE: EFU) and the ProShares UltraShort MSCI Emerging Markets ETF (NYSEArca: EEV).

Generally, the value of foreign securities is negatively impacted with a strengthening dollar.

Commodities and the Dollar

A third way to capitalize on a strengthening dollar is to bet against commodities. A strengthening dollar is frequently met with lower commodity prices. And that’s been the case in 2010.

Because commodities are priced in dollars, their value generally falls when the dollar rises. For example, the iShares S&P GSCI Commodity Index Trust (NYSE: GSG) has a 12.7% loss for the year. GSG tracks a basket of 24 different commodities futures contracts like aluminum, livestock, and natural gas.

The ProShares UltraShort DJ-UBS Commodity ETF (NYSE: CMD) is ahead by 5.29% so far this year. CMD aims for two times daily inverse performance to a basket of 19 commodities. Sector components within the underlying index include agriculture, energy, livestock and metals.

Interestingly, one commodity that has not been hurt by the dollar’s recent gains is gold. The SPDR Gold Trust (NYSE: GLD) which tracks the price of gold bullion is up 13.80%. Gold has remained stubbornly above $1,000 per ounce. GLD’s share price of around $121 reflects 1/10 the price of physical gold bullion.

The dollar’s rise, nice as it may seem, could be a short lived phenomenon. Some pundits argue the only reason the dollar has risen in value versus the euro is because there aren’t any attractive currency alternatives.

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