How to Make Money on the Weak Yen

 | Apr 22, 2013 | 5:55 PM EDT
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Friday's meeting of the G20 economies gave the green light to Japan's efforts to re-inflate its economy by weakening the yen. And I now expect that the yen will take another run at breaking below the 100 yen to the dollar level. Once the currency has fallen through that support, the next stop is 105, in my opinion.

It's time to increase your exposure to Japanese stocks that leverage this 5% move in the currency.

Certainly the Nikkei 225 index reacted that way overnight. The index climbed almost 1.9% on the session in Tokyo. And some individual stocks did even better with Mazda Motor (7261.JP), for example, rising 5.9% in Tokyo, Mitsubishi Motor 4.9%, and Olympus 5.4%.

Those gains are important because they show a U.S. investor how owning shares of a Japanese exporter during this plunge in the yen can give you the kind of leverage you need to do more than break even on the currency move. After all, if you bought a Japanese stock and it went up 5% in yen terms but a U.S. investor gave back all of that on the fall of the yen against the dollar, then what's the point?

I think, however, that you get three kinds of leverage from owning the right Japanese stock in this situation that can help you beat this currency one hand gives while the other takes away.

First, the decline of the yen means that companies with substantial production in Japan will see the cost of their products fall for customers using stronger currencies such as the dollar and yuan. That means more sales. Oddly enough the biggest benefit will go to companies with mediocre management that have been slow to move production out of Japan. Mazda Motor, for example, which still produces more than 70% of its cars in Japan will get a bigger bang from a falling yen than Honda Motor, which has been aggressive about moving production to the U.S. and other markets. Honda Motor was up only 1.7% overnight to Mazda's 5.9%. (This also argues strongly that this is a yen trade strategy. Mazda is a better yen play here precisely because it is such a badly managed company. In the longer run that isn't the kind of company you want to own.)

Second, the decline of the yen will pile on more leverage because companies will translate those increased sales in dollars and yuan back into weaker yen. Income statements will show an increase in revenue and earnings from the translation. This effect will get amplified further because after years of getting bashed by the stronger yen, company managements and Tokyo analysts have been very conservative in their estimates of the yen/dollar exchange rate. Many companies issued guidance at 80 yen to the dollar and have only recently began to recalculate results at 90 yen to the dollar -- at a time when the yen is pressing 100 to the dollar. This will lead to a round of increased earnings guidance as companies report their full 2013 earnings for the fiscal year ended March 31. Some of the current strength in the Nikkei is a result of anticipation of that improved guidance.

Third, and finally, there's the leverage to the actual currency move that comes from anticipation of further currency moves. Once the yen has fallen below 100 to the dollar and 105 to the dollar has come into play, some traders will begin anticipating 110 to the dollar. (I'd think about taking my gains once that thinking comes into play but we've got a while yet.)

The best stocks for getting the full effect of all this yen dollar leverage only trade in Tokyo I'm afraid. But if your broker can buy in that market for you I'd suggest Hino Motors (7205.JP) and Mazda Motor.

If you can only trade in New York, the best ADRs to use in this currency trade are Toyota Motor (TM), Canon (CAJ), and Mitsubishi UFJ Financial Group (MTU). Unfortunately, these are well run companies that won't get the same bounce as you'd get from a Mazda, but the leverage is still attractive.

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