Yen Surging: FXY Or YCS?

As of Aug. 23, the yen was up 6.9 percent versus the dollar over three months, as investors piled into so-called safe-haven currencies like the yen and Swiss franc. In fact, these currencies have risen so much that it’s forced interventions from their respective central banks.

Analysts estimate that the Bank of Japan (BOJ) may have spent a record 4.5 trillion yen in its most recent intervention on Aug. 4 to stem the yen’s appreciation. While that news quickly sent the yen tumbling almost 3 percent against the dollar, it rebounded within days.

So how have ETF investors been playing this seemingly unstoppable trend?

To get a grasp of investor sentiment over the past few months, I looked at the fund flows and short interest of the popular CurrencyShares Japanese Yen Fund (NYSEArca:FXY). I also pulled up fund flows for a popular 2X leveraged short fund, the ProShares UltraShort Yen Fund (NYSEArca:YCS).

Fund Flows ($M)
6/30/2011 7/31/2011 8/19/2011
FXY -25 31 51
YCS 4.5 -10.5 -43

Looking at fund flows, the leveraged short-yen fund had outflows of $10.5 million in July and, through Aug. 19 of this month, another $43 million in redemptions. FXY, on the other hand, had net inflows of $31 million in July and $51 million for the same periods, respectively.

FXY - CurrencyShares Japanese Yen Trust
5/31/2011 6/30/2011 7/31/2011
Percent of Float Short 122% 98.30% 74%
Short Interest Ratio 12.95 7.27 6.4

As of May 31, over 120 percent of FXY’s long float was short. But short interest is now down to 74 percent, suggesting short covering. The short interest ratio, a measure of how many days it might take to cover all shorts based on daily trading volume, also dropped:by more than half from almost 13 percent since the end of May to 6.4.

Assets under management have also seen a large shift. FXY saw its assets balloon from $152 million on June 30 to roughly $270 million as of Aug. 23. During that same period, assets in YCS fell from $363 million to $275 million.

Judging by this data, it seems investors are becoming more bullish—or reducing their shorts—on the yen just as the yen is surging to new highs. Uncertainty surrounding sovereign-debt issues in Europe and Standard & Poor’s downgrade of U.S. debt likely contributed to this change in flows as well.

Will this bullish response pay off? Maybe.

The strong yen might continue to face head winds from Japan’s central bank. It’s really a question of whether the BOJ has the capacity to turn the tide alone. The last time the BOJ intervened, on Aug. 4, just four days later, the yen fully recovered and was on its way to new highs.

For ETF investors looking to speculate on the yen with these funds, there are a few factors to remember.

FXY is structured as a grantor trust, and gains are generally treated as ordinary income regardless of how long the shares are held. Gains made from short selling are also taxed as ordinary income. And since FXY isn’t paying out any dividends, short sellers currently don’t have to worry about having to pay out dividends to the owners of the shares.

YCS, on the other hand, is classified as a partnership for tax purposes. This means that gains and losses are reported on a Schedule K-1, instead of a 1099 that most investors are accustomed to.

And, because it holds futures contracts, YCS is taxed at a maximum blended rate of 23 percent (60 percent of gains are taxed as long term, while 40 percent of gains are taxed as short term), regardless of how long the shares are held.

YCS is also designed for short-term trading due to its daily leverage reset. So over time, the effects of daily compounding can negatively impact the fund’s returns in volatile markets.

Yen speculators and investors will continue to stay tuned for any further interventions from the BOJ. The yen could also see some movement depending on Ben Bernanke’s speech this Friday and the outcome of the Fed’s annual conference in Jackson Hole, Wyo.

For now, ETF investors look to be selling YCS and covering their shorts in FXY. But with all the uncertainty surrounding central bank interventions, that could easily change again in the coming months.


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Copyright ® 2011 IndexUniverse LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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