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Tuesday, May 26, 2009

How to Profit from Possible U.S. Credit Downgrade

With the Outlook on UK's credit getting reduced Thursday, it gave serious speculation that a US credit downgrade could soon follow. The reason for this speculation is because the US and UK have spent way too much money!

If the U.S. credit gets downgraded I imagine the dollar will become much weaker. I believe it will sink lower than the lows set in summer of 2008. Some ways to take advantage of a weak dollar are outlined below. I have been implementing various option strategies to take advantage of some of the moves I expect [if the US credit gets downgraded]. To see a list of option strategies I have been using check out my blog.

Getting Short the US Dollar

This is the most straightforward thing to do if you expect a weak dollar; you just need to know when to cover.

The Good: If the credit gets downgraded the dollar should sink, and you should be able to make a profit off this play.

The Bad: If the credit doesn't get downgraded- I imagine the dollar will move sideways if not get a bit stronger causing a loss in this play.

Some ways to short the dollar without getting into FOREX is playing the PowerShares bearish USD ETF (UDN). I have been buying near the money option call spreads on the UDN as my hedge against a credit downgrade.

Getting Long Gold (or other precious metals)

Gold trades in US dollars, therefore a weak US dollar causes gold to rise.

The Good: If the dollar gets weak, we could see gold hit record levels in the months to come. If you're long gold as it is hitting new highs, then you should be able to pull a profit by riding gold up.

The Bad: Similar to the dollar, if the US credit does not get downgraded in the months to come, it could cause gold to move sideways or perhaps depreciate in the near term. (Near term because I expect gold to rise significantly, as I expect inflation to be very high within the next 18 months).

Some ways to take advantage of the price of gold rising would be buying the hard asset, or an ETF which tracks the performance of gold (although criticized by many, I use this strategy) such as GLD, UGL

Getting Long Crude Oil (or other commodities)

Just like gold, crude too is traded in US dollars, and a depreciation of the dollar could cause crude to heat up. Looking at a chart we can see that crude oil peaked while the dollar was the weakest (in terms of the Euro) within 1 month of each other.

The Good: If the dollar gets weak, I believe we could see oil get back to the $70-$80 per barrel range fairly easy, if you're long black gold as it is shooting up, you should be able to take some profits along the way.

The Bad: A downgrade on the US credit could signal a rougher road ahead, causing oil to collapse (demand side).

Some ways to play crude oil as well as other commodities include ETF's such as USO, UCO (double leveraged), GSG, as well as some oil service names that may benefit from the price crude increasing.

Getting Long Big Exporters

This may be the silver lining of the bunch. If the dollar gets crushed on a credit downgrade, we know from basic economics exports are sure to rise.

The Good: If the dollar gets weaker, it is sure to cause an increased demand for American made goods, causing a company’s sales to increase (maintaining the same margins) and showing up on the bottom line. If you hold a long position in a company who is benefiting from a weak dollar, you should see a more valuable equity.

The Bad: It could take months before a company shows any benefits from a weak dollar. If the overall market sells off on the news of a credit downgrade, the benefits received from increased exports and profitability may simply just offset the initial sell off.

Look for companies who export high dollar merchandise. One company I am buying longer term out of the money bull call spreads on is Caterpillar (CAT). This is because Asia is still demanding heavy machinery and will demand more if it becomes cheaper to them.

All of these cases are ways to profit from a weak dollar. Although it may seem like I am pulling for a US credit downgrade from this article, as I state "The good", I assure you I am not.

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