Dear Reader,
“What purpose does the pound serve in an investor’s portfolio?” I ask.
“Well, it used to be a high yield currency,” replies my contact down the line.
Used to be…
It’s a debate that I’ve had with all of my colleagues and contacts and I’m coming to the conclusion that the pound is a pointless, directionless trade.
Consider the dollar, yen and Swissy. These currencies are safe havens in times of heightened fear. That’s when they go up. Conversely, the Kiwi, Brazilian Real and Norwegian Krone go up when commodities, and more generally when market-wide risk tolerance goes up. And then there’s any number of arguments for the Chinese Yuan and Australian dollar from yield to economic growth.
But when it comes to the pound, there is no narrative. There is no story to tell. We have no commodities, we have no economic growth and, thanks to the credit crunch, we don’t even a high rate of interest. There is no reason for a speculator to own a pound. It’s not even cheap any more.
And yes I know that every day more than $3 trillion changes hands in the market for a myriad of reasons. However, speculation ranks just as highly as any commercial (import / export) drivers for trading currencies. And currently, the only speculative driver for the pound is momentum. Its rises and falls have become increasingly difficult to predict, and we say that as investors who profited handsomely from the pound just 6 months ago.
Nonetheless, I’m now thinking it may be time to reconsider a short position on the pound. Why?...
The threat to the goldilocks of the FX world
On the face of it, the UK appears to be neither too hot nor too cold…
We have neither the highest or lowest interest rates among the majors, so the pound is unlikely to find itself on either side of the famous “carry trade.” This is the popular trading strategy where investors pay the yield on a low yielding currency and receive the yield on a high yielding currency.
We’re not especially over- or undervalued. On The Economist’s Big Mac index, the pound is just about the most fairly priced currency of the bunch. Using the US dollar as a benchmark, the equivalent Big Mac in the UK will cost just 3% more. By contrast, the Euro is very overvalued at 29% over the dollar.
The only influence that appears to seriously affect the pound now is news flow. Quantitative easing and debt ratings are the two hot button topics that can still extol influence on the value of the pound. Take for example a fortnight ago where the Bank of England announced adding another £50 billion to the quantitative easing pot and the pound fell more than 500 basis points in a very short space of time as you can see from the chart below.
The devalued pound: More money-printing breaks the pound’s uptrend
Source: Barclays Wealth
This negative impact was cemented on Wednesday when the minutes of that fateful meeting were released. From the FT: “Sterling fell on Wednesday after minutes from the last Bank of England meeting revealed governor Mervyn King had called for a greater expansion of the Bank’s asset purchase scheme.”
A long-term punt on the pound is a gamble on whether this type of news flow will be sustained. We think it is likely but will not “bet the farm” on such a flimsy indicator as news flow.
So how should we play the pound?
Don’t go short the pound, go long the market
There is a big difference between the UK stock market and the UK economy. What’s bad for one is not necessarily bad for the other. And pound weakness is a prime example of unexpectedly good news for many of our holdings.
You see, sterling weakness could provide a positive earnings surprise in many of our holdings. Companies like British American Tobacco benefit greatly when the pound is weak, as they earn so much of their money in other currencies. Other holdings that similarly benefit from the falls in the pound are:
Our recommendation would be to go for the indirect plays on the pound until the trend becomes clearer. As we said back in February, there is no doubt that the pound is in the mire. However, it is not as clear cut as that is why we opt for this safer way to play the trend. Aim your portfolios at international exporters like British American Tobacco (ticker: BATS), Diageo (ticker: DGE) and Inchcape (ticker: INCH) which should be boosted by future falls in the pound.
If the pound collapses, you could win big. And the bonus of this type of approach is that even if it doesn’t collapse, these stocks have enough price drivers away from currency.
It’s a win-win, low-risk strategy to short the pound at an arm’s length.
Best wishes,
Theo Casey
For The Right Side
Editor’s note: Theo Casey is investment director of The Fleet Street Letter, the UK’s longest-running investment newsletter. They’ve just released a bold prediction about the biggest threat to your wealth this year and next. Don’t miss out on it. Read here to see how you can protect yourself and even profit.
Please note: Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares; never risk more than you can afford to lose. Please seek independent financial advice if necessary.
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