How to protect your wealth from the plunging pound

Sterling has fallen dramatically recently - and it doesn't look like recovering anytime soon. John Stepek explains why, what it means for Britain, and how to invest to protect your wealth.

Risk-hungry investors have been buoying up sterling in recent months as their appetite for bombed-out, no-hope investments has grown.

However, the pound looks as though it's now returning to its traditional role as the whipping boy of the currency markets.

It's even managed to fall against the dollar in the past few days, which is quite an achievement given the general level of aversion to the US currency.

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So what's the problem?

We heard a lot about the 'staycation' this year. Apparently lots of people holidayed in Britain to avoid the pains of the high euro, and cut the costs of their summer break.

But judging by the various "never again" comments from 'staycationing' newspaper columnists bemoaning the British food and weather, a lot of these people are probably hoping to go abroad next year.

Unfortunately for them, it doesn't look like a trip to the continent or anywhere else is going to get any cheaper. Several City analysts are now predicting that sterling will again fall to parity with the euro. In fact, at least one Michael Hart at Citigroup reckons sterling will be worth less than one euro at some point in the next few months.

Why the sudden aversion to sterling?

So why the sudden aversion to sterling? It's pretty straightforward. The Bank of England very kindly spelled it out for the market in its latest quarterly bulletin. The Bank, reports the FT, said that "changes to Britain's relative economic outlook, the perceived riskiness of its assets and the need for the economy to rebalance away from domestic consumption" had been the major factors in the pound's 20% trade-weighted slide over the past two years.

In other words, Britain has fallen way down the global pecking order of economies you might want to invest in. And worse still, these changes might be permanent. The whole financial crisis, says the Bank, might mean that in the long run, overseas investors are less willing to lend us money, which means a permanently weaker pound.

This was nothing we didn't already know. But it's the fact that the Bank doesn't seem to want to do anything about it that's spooked the market. The report comes after last week's comments from Mervyn King that he might cut interest rates further, or even turn them negative (ie, charge commercial banks to hold money with the Bank of England) to force banks to lend more. This has already been done by the Swedish central bank, by the way, so it's not as far-fetched as it may sound.

In short, the Bank of England has shown the market very clearly that sterling is the last thing it's worried about right now.


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If any country can avoid deflation, it's Britain

So what's Mr King really fretting about? Well, he's still nervy about deflation. And this is the other factor making investors paranoid about Britain. With markets booming across the globe, the majority of investors are now bullish. Back in June, most investors believed this was a short-term bear market rally, according to Barclays Capital. Now, most believe we're in a sustainable bull market.

With most investors looking for a recovery, they're starting to wonder when interest rates will rise. So the fact that Mr King is still worrying about deflation and threatening to cut rates further is making investors wonder what he knows that they don't. Is Britain in an even worse state than the rest of the world? As Melinda Burgess at Royal Bank of Scotland puts it: "the risk now is that the UK will be left behind in the global economic recovery and interest rates will be on hold for longer than most."

As we've said here before, if any country can avoid deflation (and here we use the term to mean falling prices, rather than a falling money supply), then it's Britain (Don't fall for the deflation hype). But that's not necessarily something to celebrate. The reason we can avoid deflation more easily than other countries is because we are in the best position to destroy the value of our currency and thus push up relative prices.

Every other major country has problems too, but devaluation isn't quite as easy for them. America might quite like to have a weak dollar, but it has to be wary of losing its status as the global reserve currency. The euro is an integral part of the European project, and will be defended strongly by the European Central Bank.

How to protect your wealth

So betting on a weaker pound seems like a reasonable move. That's good news for many of the defensive stocks we've been tipping big drugmakers such as Glaxo and AstraZeneca earn and pay dividends in dollars, as do oil stocks such as BP and Shell. It's also a good reason to have some of your portfolio in emerging markets (How to profit as wealth and power head East) and in Japan. If you haven't already done so, signup for our free weekly email covering Asia and Asian investments.

And of course, there's gold. Sterling might be the least popular currency for the time being, but all paper currencies are under threat amid all the money-printing around the globe. The recent rally in gold partly reflects that. And that's one of the reasons that, as sterling investors, we'd still be willing to buy gold here, particularly if you don't have any. Not because we necessarily believe it's going to make you a fortune in the short-term. But because, if we do get some sort of major currency crisis in either the dollar or the pound, then gold will give you some sort of insurance against all the upheaval that will inevitably result across the rest of your portfolio.

MoneyWeek's editor-in-chief, Merryn Somerset Webb, looks at ways to invest in gold in our recommended article, below.

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As governments compete to destroy the value of their currencies, there can be only one result for gold. Merryn Somerset Webb explains why, and suggests the best ways to invest in the yellow metal.

John Stepek

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.