The pound will get trashed. What can you do?

The pound has fallen hard since the start of the year.

It started 2013 at around $1.63; it’s now hovering around the $1.50 mark.

Yet it looks very much like it could have further to fall. Britain’s government seems to be all out of ideas on how to boost growth. Instead, George Osborne would rather dump the hard work on the central bank.

And there’s only one thing a central banker can do in these circumstances.

Trash the currency…

Britain’s business model is broken, and no one is trying to fix it

Chancellor George Osborne isn’t backing down, reports the FT this morning.

As far as he’s concerned, he’s sticking to his plan. There’ll be ‘fiscal discipline’, combined with slack monetary policy. The idea is that easy money from the central bank will offset the squeeze from the government.

Now, you’ll hear lots of wailing about how awful austerity is for the economy. About how the chancellor should reverse course and boost growth by borrowing more money – after all, it’s so cheap right now.

This is all rubbish. It’s a false debate. Britain’s problems are structural. We’ve relied too much on banks and the housing market. The tax take from that fuelled expansion by the state. The banks went bust. The housing market is being propped up for political reasons. The tax take is down. In other words, Britain’s business model is broken, and we need a new one.

But the only strategy the government and the opposition have is to try to return to the days of the boom. ‘Austerity’ as it currently works, is designed – at best – to trim our deficit and keep markets from selling our debt en masse. Loose monetary policy is meant to boost inflation, and help the banks get back to square one, so that the days of easy lending and cheap mortgages can return.

So Bank of England monetary policy is only going to get more inflationary. And that means more bad news for sterling.

Get exposure to non-sterling assets

So how can you protect yourself, and even benefit from a weaker pound? If you like the idea of having a punt on the pound, you could take out a spread bet. But I’d be wary of doing it today. The Bank may well announce more quantitative easing (QE). I think it’s quite likely.

But if it doesn’t, the pound will probably rebound quite strongly. So a short-term bet is nothing more than a pure gamble on what mood Sir Mervyn King is in today. (If you are still interested in spread betting, you can sign up for our free trading email, MoneyWeek Trader.)

In the longer run however, I can see sterling falling a good bit further from here. So I’d continue to recommend that you diversify your portfolio in currency terms.

For example, I was looking at the performance of Japan’s Nikkei 225 since the start of the year. In yen terms, it’s up about 11%.

Now, we all know that one of the key drivers of Japan’s recent comeback, is the fact that the government has all but said that the yen is toast. The currency has weakened from 77 to the dollar last year, to around 94 now.

So we’ve been asking ourselves if you should hedge your currency exposure or not. If you hedge the currency (ie get full exposure to Japan in yen terms), you’ll get the full benefit if any further yen weakness boosts stocks further. But if the yen strengthens, and stocks fall, you’ll be exposed to the full pain of that too. 

But if you’re a sterling investor, the question might not matter that much anyway. If you look at the Nikkei in sterling terms, since the start of the year, it’s also up by 10% – pretty much the same, in other words. That’s because the pound has been such a duffer of the currency this year, that it’s roughly matched the yen’s decline. 

My point is, if you agree that sterling – for now at least – looks like the lame duck of the foreign exchange world, then as long as you buy cheap overseas assets, any gains you make shouldn’t be too badly hit by currency effects. Indeed, in many cases, the currency impact will boost your returns.

That’s why I’d be happy to have exposure to cheap stocks denominated in euros. I still like the look of Italian stocks (yes, Italian politics are ridiculous, but name me a time when they weren’t). But you could opt for something more diversified. We’ve tipped the Montanaro European Smaller Companies Trust (LSE: MTE) in the past.

I also still like blue-chips with US dollar exposure. Yes they’re a bit dull, and the whole ‘safety first’ trade has been done to death. But look at GlaxoSmithKline (LSE: GSK) for example (I own this stock, for full disclosure). In terms of its share price, it’s got to be a contender for one of the dullest stocks in the FTSE 100 over the past five years. But with a big chunk of its revenues in US dollars, and still paying a dividend yield of more than 5%, I can’t see any good reason not to hang on to it. There are plenty of others like it in the main index.

And my colleague Phil Oakley threw another interesting idea at me across the desk the other day – US inflation-protected government bonds (Tips). We don’t like traditional government bonds, for reasons we’ve made pretty clear (if inflation take off, and QE stops, they’ll be hammered). But if you can get an inflation-protected bond, that’s very different. You get the protection for when inflation takes off, and you also get the kicker of the strengthening US dollar behind it. I’ll be getting Phil to write up the idea for a future piece in MoneyWeek magazine (do subscribe if you haven’t already – you can get your first three issues free, so you’ve nothing to lose by trying it).

I’ll not forget gold, of course. We see gold as insurance – you hold 10% of your portfolio in it (so when you rebalance, you sell some if it’s above that, and you buy some if it’s below that). Gold has had a pretty poor year so far amid the euphoria – it’s down about 6% in US dollar terms. Yet again, the weakness of sterling means that for a British investor, it’s flat, not down.

On gold by the way, keep an eye out for an email hitting your inbox this weekend. It’s from our gold expert Simon Popple – he’s been digging through the data and reckons he’s found an interesting story in the gold market. You can see what he’s dug up on Saturday afternoon.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here.

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  • farmideas

    Your suggestion to back gold has not paid off, despite your rhetoric. What has farm land been doing? Practical Farm Ideas has shown huge growth in this market.

  • Jim

    John

    Why do you always insist on 10% in gold?

    Sounds like a nice round number plucked out of the air.

    Here’s a number 73% invested in gold, money printing to infinity why not.

    Please don’t mention Japan they are finished.

    Btw I bought silver at $11

  • JREwing

    @ Jim – great move! I wish I had done that. I wanted to buy silver after Lehman when it was at $8 but I couldn’t do it as buying physical in a safe manner was almost impossible. So I bought gold at $700 instead.

    You must be laughing today.

  • JREwing

    @ John Stepek – the government’s “devalue your way out of trouble” strategy has not worked yet and it won’t work. Much of the deficit and the debt on the state’s balance sheet is structural, not historic. This is why they cannot cut the deficit further without a massive cull. How do you reduce the state as a percentage of GDP with the NHS sucking in hundreds of billions annually?

    It doesn’t matter how much they trash the currency, the debt will keep mounting. There is a crisis on the way. The only thing worth debating is the timetable. My bet is on a Millibrain victory in 2015 and then an “event” afterwards.

  • Roger

    If all stories here are true, the best strategy, buy USD (albeit a few month ago in massive quantities), immigrate or send kids to USA, because there is energy independence and manufacturing returning, prosperity is in sight. They also has Bernanky, who has done so far, WELL.

  • cliff hanger

    JREwing,

    Correct, it is as plain as the nose on your face that the current strategy of ZIRP/funny money/devaluation has not worked and we have a flat-lining economy after 4 years of this folly.

    No guessing what the political elite will choose, yes more of the same insanity. This will not end well.

  • Changing Man

    If the gold price continues to fall as fast as sterling then you may as well just hold cash in a building society @3% interest rate and avoid the valuation risk, transaction and holding costs of gold? No one knows what gold will do next but if its just being held for insurance then should you not also carry a hedge against it devaluing faster than sterling e.g. via a gold short £ long holding?
    Suggestion for next week’s MW headline: “Is cash the new gold?”

  • Fitter

    @farmideas

    Moneyweek has been tipping gold for years. If you bought gold initiall you’d be sitting on significant profits.

    Sorry your timings been off.

  • JREwing

    @ Changingman – if you own any physical gold, I am more than happy to buy it off you at the current price. If you have any mates with physical gold holdings, I am more than happy to buy it off them too (at current price).

  • Boris MacDonut

    A lot of pundits are pointing to $1.45 as the new normal. Time to rethink the trips to Florida or shopping in New York.

  • Changing Man

    #9 Thanks JR but will you agree to buy it at today’s price in 1 year’s time, 2 year’s time? Only then will we know the real cost of holding this “insurance” for our currency! I think Money Week (and its loyal goldbugs) may be finding it difficult to readjust to a scenario where gold isn’t all upside?

  • Davros

    with negative real rates as far as the eye can see, there is no opportunity cost of holding gold instead of putting it into cash. Also, the Bank of England will “print” a lot more currency, just using a few strokes on a keyboard. But with gold, they can’t print it; rather it has to be dug out of the ground and that’s expensive. We are in the foothills before the “escape velocity” of the Carney/Osborne Zimbabwe/Weimar Experiment…..calm before the storm….

  • Sidney Rough Diamond

    4 @JREwing

    I think you are spot on in your analysis. I also believe we are heading for an ‘event’ and it will come within the first two years of a Milliband premiership. If you look at it in a historical context we are entering something akin to the seventies. However, in the seventies Britain still had a decent manufacturing base, and was a nation of savers. Now we are a nation of debt junkies leveraged up to our eyeballs, which makes us more vulnerable to ‘events’. I also think interest rates will be kept near zero indefinitely which will only compound the problem … Tough times ahead !!

  • JREwing

    @ Changingman – Let’s do a simple agreement. I will buy gold off you at the current STERLING price in two years. You keep the physical gold (everything you’ve got and eveything your mates have got) with an escrow account manager in Switzerland. I will, in turn, pay that escrow account manager in Switzerland the current STERLING price in two years from now and take the gold off them. If I don’t pay, you can sue me for the entire sum payable in STERLING and force me to take the gold. The courts in Hong Kong are very fast at enforcing debts (even faster than banker friendly English courts). Deal?

    If you don’t like Switzerland, you can also keep your gold in Singapore or Hong Kong. The ball is in your court.

  • JREwing

    @ 13 Sidney Rough Diamond – your handle reminds me of one of my favourite films of all time. Brilliant stuff!

    RE: Millibrain, I think the UK economy has about three years at the max before it has an “event”. I think there are really two possibilities at that point: (1) no one comes to Britain’s aid and you get, ahem, interesting inflation rates; or (2) the Yanks bail the British out since the British banks are leveraged to kingdom come and if they go down, like Samson, they take the world with them.

    But the Yanks have no money with which to bail out Britain. So how they do it? Your guess is as good as mine.

  • JREwing

    @ 13 Sidney Rough Diamond – the current situation is actually quite different from the 1970s (in fact, far worse). For a start, look at the debt to GDP ratio in 1976 when Britain needed an IMF bailout. Then look at it today. But this comparison also understates the extent of the problem. If you add non-Sovereign Debt, the ratio is 20 times worse.

    In the 1970s,life was actually good. The Americans were still the biggest creditors on the planet and they handed out the cash to bail us out, our population was a lot younger and the state far smaller as a percentage of the economy. In addition, we hadn’t even begun to tap into the oil in the North Sea. For a good two decades that oil kept our trade deficit close to zero and created a massive economic boom. This time, we have none of those things.

  • Sidney Rough Diamond

    @ 16 JREwing

    I agree. When you look at media reports ‘winter of discontent’ and all that, Britain seemed to be going to the dogs, but actually life wasn’t too bad for a lot of people. What has happened since the early 80’s through is debt creation has given us an ‘illusion’ of wealth creation, which we all know is rubbish. In reality we are probably a lot weaker now than we where in the seventies ( for all the reasons you stated, and a few more ) I originally thought this recession would be over in about 12 years. Then we would slowly start to recover and grow, albeit from very very weak base. Now I’m not too sure.

  • JREwing

    @ Sidney Rough Diamond – I think the biggest difference between the two eras would be the number of people totally dependant on the state and living off the state. This, to me, is the most important difference. Everything else pales into irrelevance.

  • Anon

    I used to agree with everyones views about the UK economy being toast, but in a year or two you are all going to get the shock of your lives regarding huge resources which the UK owns. It WILL turn the economy around, but will they squander it like they did with its oil reserves?

    You (possibly) read it here first !!!

  • lennybogart

    With China soon becoming the no. 1 importer of energy and a reliance on coal and oil, why don’t we re open our coal mines and sign deals with China to provide them with coal, bringing jobs and exports to our economy.

    Can anyone tell me if this may have a positive effect?

    A desperate effort, maybe, but these are desperate times…

  • Changing Man

    Re#14: Sorry JR, I don’t think we need to trouble the gnomes of Zurich with my meagre collection of gold coins! I am not a bullion hoarder for the simple reason that I can’t predict it’s medium to long-term future value any more than you can. Short term I am shorting the gold price. If you read the article in the FT yesterday you will have seen that a massive sell-of in gold ETFS has taken place this year and the holding in gold through these ETFS dwarfs that held in Switzerland so it has a very significant effect on price.
    Coverage of this vital trend has been sorely missing from MW editorials. In my view we need to move beyond the rhetoric, posturing and prejudice of “gold bullying” and have a better understanding of the risks in holding this asset class.

  • Arogueant

    Have now seen a few recommendations from Money Week to buy into ‘cheap’ stock markets as part of a hedge against the ‘Britain going bust’ theme. Can anyone help me understand what should be considered in choosing the correct fund to do this with assuming I believe it to be good advice? Should it be an offshore fund? Should it have a base currency other than sterling? Should it be managed by a non-UK firm? Any help would be much appreciated as I can’t get my head around whether some or all of these requirements would need to be met to truly hedge against a devaluation of sterling. Thanks in advance

  • Changing Man

    Re#22, I think the theory is that if you buy sterling-priced funds that hold companies with earnings predominately in other currencies then if sterling falls faster than the foreign currencies, the value of the fund “should” rise in sterling terms.
    However with many countries trying to devalue their currencies it becomes more complex. Also the success of companies within the fund can depend on their competitiveness which can be driven by foreign exchange rates for both imports and exports.
    I think it best to follow the general rules about holding a diverse portfolio and buying when cheaper hence that’s why Japan and Russia and Italy are tipped as value opportunities in this article. Personally I hold Japan, Russian, US and frontier market funds for diversification but feel Italy is a lottery due to the Euro situation.

  • kramrenraw

    noone including moneyweek mag to which i subscribe,ever mentions just opening a foreign currency account and switching some sterling to say dollars..why? it seems a simple way to hedge against sterling devaluation . am i missing something here ?…. some of us dont want equity risk anymore because or our ages.

  • Poutine

    other assets : gold, vineyards, forestry, euro shares (!), nikkei (with a quanto for the currency exposure). Everywhere you can find something to make money.

  • Colin Selig-Smith

    Another suggestion.

    Chinese government bonds. China pegs the CNY to the USD. Which means the US is able to export it’s inflation to China. That’s by the by. Because of the peg you are *effectively invested in dollars*.

    Now with the inflation problem which China has due to US QE, it seems likely that they will break the peg or continue to allow the CNY to appreciate. At which point the CNY will appreciate substantially, and the value of your CGBs will appreciate along with them. In the meantime you get 3.6% yield from the CGB 10 year vs 2% from the US 10 year.

    The Chinese government is effectively subsidising your bond purchase with it’s peg to the USD.

    Or do you think the CNY is overvalued?

  • Gold/$US man

    I bough gold shares at the end of last year and they have been a disaster!
    However buying both gold shares and physical gold NOW must be good with a Minibrain government due in May 2015
    I have recently opened a USD offshore account (as kramrenraw suggested) at about $1.50 It pays 2%, same interest rate as a UK BS with capital growth within 6 months?

  • sandy mcdonald

    Why have you failed to mention that your editor, Ms. Somerset Webb, is a director and shareholder of Montanaro?

  • Paul

    Has anyone notice that the B0E has restarted gilt purchases this week, first time since October last year when they reach the agreed level of £375bn, they have now exceeded this by £3.3bn, thoughts? Gilt coming under pressure by the market, yields to rise without the BoE.

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