Five stocks to profit from a weak pound

published 4 March 2010

We noted earlier this week that playing the forex markets is a dangerous game.

Currency trading is a volatile business. And it's not really a 'buy and hold' investment. So timing matters. And yesterday, anyone still betting on a plunge in sterling or the euro would have had their fingers burned as both currencies rebounded.

So is there any way you can bet on a longer term decline in the pound, for example? Well, Goldman Sachs, the much-maligned 'vampire squid' of investment banking, thinks it might have the answer...

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Problems for the euro and sterling are far from over

Both the euro and sterling saw big bounces yesterday. On the euro side, the Greeks have decided to cut spending further, and jack up taxes. They're also threatening to go to the International Monetary Fund if Europe doesn't agree to help them out. So traders are increasingly confident that the euro will muddle through. As for sterling, some strong consumer confidence and service sector data saw the pound bounce back from its recent election-inspired spasm of fear.

Are these currencies' troubles over? Not by a long chalk. Greece just happens to be top of the eurozone worry pile right now. Plenty of other countries in the region are capable of going the same way. And the Germans remain very reluctant to commit to any suggestion that they'll be sending money Greece's way. More scares are inevitable.

The pound also remains vulnerable. We have a Budget to get through before the election (assuming it isn't called early, which, given Gordon Brown's track record, seems unlikely). And every time Mervyn King opens his mouth, or another opinion poll is published, traders will have their fingers hovering over the 'sell' button.

The British economy isn't in recovery

On top of that, we're not convinced the British economy is in recovery territory yet. House prices are still too high, while sales levels are too low. It might seem odd to point to the property market first. But as my colleague Merryn Somerset Webb points out in the latest issue of MoneyWeek (out tomorrow if you're not already a subscriber, subscribe to MoneyWeek magazine), our country's economic growth is unusually dependent on the path of house prices. Higher prices fuel more consumer spending, as people borrow against the value of their homes. Lower prices, on the other hand, make home owners feel poorer and less secure about carrying heavy debt loads.

And it's hard to see a way out of our current situation that doesn't involve prices falling. Public sector spending cuts are likely to result in higher unemployment. And if they're not tackled fast enough, then borrowing costs may well go up too.

In short, things don't look too rosy in the longer run for the UK economy, nor for the pound.

How to profit as the pound falls

And plenty of other people are fretting about sterling too. So much so that Goldman Sachs, which is otherwise quite upbeat on the UK stock market, has come up with a suggestion for profiting from further falls, says FT Alphaville. "We have two baskets to help position for further sterling weakness. We recommend going long UK companies with international exposure that tend to exhibit negative correlation with the pound" i.e. they rise when the pound falls and vice versa "and short UK domestic companies that are generally positively correlated with the pound."

Special FREE report from MoneyWeek magazine: When will house prices bottom out - and how will you know?

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Now, before we look at some of the stocks they suggest, let's make it clear that investing in any asset simply to bet on currency exposure alone isn't a good idea. There's no point in buying a dollar-earning stock if it goes bankrupt. But as long as the underlying stock is decent enough, then investing in companies that draw their sales and profits from a wide range of countries makes sense, particularly if you're downbeat about Britain's near-future.

So what's in Goldman's 'long' basket? Among other things, the bank suggests gold miner Randgold Resources, defence giant BAE, healthcare groups AstraZeneca and Smith & Nephew, the oil majors, and mobile phone giant Vodafone. MoneyWeek share tipster Paul Hill shares his views on Vodafone and Smith & Nephew in this week's issue.

As for the others, many on the list look pretty expensive on a p/e basis rather than Randgold for example, I'd rather buy an exchange-traded fund tracking a basket of gold miners, or gold itself. But Astra looks reasonable on a 2010 p/e of below eight. And although there are some questions over the sustainability of the dividends, depending on what the oil price does (Just how safe is BP's dividend?), if you've already got Shell or BP we'd be happy to hang on to them. Defence group BAE also looks cheap, as my colleague David Stevenson recently pointed out: Profit from the world's defence spending.

As for what's on their 'short' list of companies exposed to the UK economy, as you might expect there are plenty of retailers on the list, including WH Smith and DSG International. We're not keen on retailers ourselves (although David has dug up one that looks too cheap to ignore) so we can't disagree there.

But we're not sure we'd want to risk shorting any of the stocks on the list. For one thing, shorting stocks is very risky (your losses are theoretically unlimited). For another, Goldman's strategy isn't based on picking and choosing from the list the idea is just to go long one basket and short the other.

However, if you are feeling bold, there is one interesting name on the list online estate agent Rightmove. Bengt Saelensminde, who writes The Right Side newsletter, reckons that Rightmove is ripe for shorting he explains why here. If you agree, you can compare spread betting providers here. But do remember if you're a beginner, practise with a dummy account first. Don't risk more than you can afford to lose. And always, always set a stop-loss.

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John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.