Sterling Comeback, Assisted By Barclays

In a market like this, it’s quite fun to keep an eye on shares that are trading so cheaply that they have a ‘binary’ outcome: either they’re going to zero or have considerable upside. Better than a binary bet because the potential upside is unlimited! The great thing about them is that when they’re near zero you know exactly how low they can go. And even if they just get a temporary bounce, there’s plenty of trading profit to be made if you can catch the move correctly. That’s why I’ve traded a fair bit in bombed out FTSE 250 stocks like Taylor Wimpey, Barratt, and DSG Group - you can manage downside risk, and you don’t need much capital to get quite a big long position on.

Barclays
With this approach in mind, at the end of last week I decided to take a punt on Barclays (BCS). It wasn’t a completely blind bet; whilst I share most people’s scepticism about the truthfulness of bankers I still think it’s worth watching a stock that’s trading on a (historic) P/E ratio of around 1 and which has taken over one of the biggest brokerages in the world for popular buys like US Treasuries, the artists formerly known as Lehmans. Something had to give, one way or the other.

I’d decided that the hysteria about the state of the banks’ balance sheets, particularly Barclays, was overdone. And I was delighted to be proved correct (even if only temporarily). I’ve added a bit on the way up and now have a £10/penny long in Barclays with a couple of hundred pounds of profit locked in. Not insignificant.

And on roughly the same principle, combined with ongoing rumours about the creation of a ‘bad bank’ to get assets off balance sheets, I went long of Bank of America (and a couple of US housebuilders) yesterday evening. That trade’s now up 10% from my entry point. Not bad either.

Sterling Has A Good Couple Of Days
Seems to me the slight recovery in the UK banks has also given Sterling a boost. Perhaps this is because it doesn’t look quite so likely that full nationalisation will occur. So the UK taxpayer may not have to take on all the liabilities of the big four high street banks - which would increase the national debt even further and be bearish for Sterling.

The bank / Sterling recover is helping UK equities hold up remarkably well. There’s also support from across the Atlantic by a sense of (misplaced?) expectation about the impact of Obama’s fiscal stimulus.

So I think it’s quite possible that GBP/USD will correct back up towards the 147-150 level against the Dollar. Sterling has devalued incredibly rapidly over the last few months, and it looks oversold. If I was wanting to sell anything against the Dollar, I’d focus more on the Yen (if equities look like rallying) and the Euro (if equities collapse) rather than the pound.

Dollar Deleveraging And The Banks
Dollar strength is all about deleveraging - people selling risky assets held abroad and repatriating the money in order to reduce their debt. And as a large chunk of the debt in the world is priced in dollars, these people have to buy dollars to pay down the debt. So the longer term bullish Dollar trend will probably stay intact so long as the deleveraging process continues.

The thing is the weaker sterling is, the more it costs the UK banks to pay down their dollar-denominated debt - which is one of the nastier side effects of the GBP being so weak. If you’ve got billions of dollars of debt on your balance sheet, the last thing you want is for it to become more expensive to service. So it follows that if sterling does correct upwards a bit the bank stocks will likely follow. A tradable bounce, if not exactly a bullish signal.

Another factor that might help UK equities is that sterling is trading near historic lows against the Euro and the Dollar. So if you’re a foreign investor you can get even more bang (or crash) for your buck. Even with all the toxicity floating around, a lot of FTSE 100 companies look cheap as investments over a longer timeframe.

So this is the deflationary and deleveraging trend we’ve been following for the last 6 months. The big question is - will it continue or will it reverse? The Dollar has had a good month so it might drop back a bit, particularly with concerns about the inflationary effect of printing money to pay for bail outs, tax cuts, new infrastructure project etc… OK, the Fed may be printing money. BUT - and this is a big but - is it printing money faster than the economy can absorb it - I don’t think so. Despite the trillions coming off the printing presses and near-zero interest rates, money is still scarce. So I don’t see an inflationary signal - yet.

Still Bearish On The Euro
The economic outlook for the UK isn’t great, but as I’ve repeatedly said, I think the outlook for mainland Europe has escaped proper scrutiny. Consumers in northern mainland Europe might not be in quite so much debt, but look at the dragging effect that plunging property prices, rising unemployment and slowing output in southern and eastern Europe will have on the Euro, not to mention cross-border trade around the Eurozone. Let’s say you’re in Germany and most of your customers are in places like Eastern Europe. None of them have any spare cash and their currencies have gone to jelly (if they’re not euros). How are you supposed to keep your factories going at last year’s production levels?

So I’m back short EUR/GBP, from a decent level of 9450, and I intend to try to hold the position until the Euro corrects downwards substantially against Sterling.

Gold Stays Strong, For Now
All of this currency devaluation, with the Dollar now showing a bit of weakness, seems to be pushing up the price of gold. I can see both sides of the argument about gold, but I won’t go into it all now. This blog is plently long enough. I’ll try to write another blog on the shiny stuff soon but for now all I’ll say is I have a core long gold position from 850 and will hold onto this view unless gold drops - and stays - below 885 for a reasonable length of time.

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