Will the pound fall below parity with the US dollar?
Dominic Frisby Jan 30, 2013
"The pound is headed to 90c against the dollar", says Paul Thomason of the Elliott Wave Market Service.
That's a prediction that's bound to get every UK investor's head turning.
And if January 2013 is anything to go by, he may have a point. The pound has gone from $1.63 to $1.57 in just a month. That may not seem like a lot, but in the currency wars, it's no insubstantial number.
But 90c? Really?
The pound looks well placed to win the currency wars
Just about every country in the world is trying to get the value of its currency down. Just about every country is trying to make its exports competitive and devalue its debt. It's why we keep hearing that phrase, 'race to the bottom'.
But the UK - with its debt, deficits, unfunded liabilities, reliance on the financial sector, lack of exports, weak government, low growth, stagnant housing market and increasing social unease - looks well-equipped to win this currency war.
So how low will it go? We start with a long-term chart, showing sterling v the dollar since 1986. You can see there is a consistent range over time. The red area - around $2 - is the obvious, longer-term sell zone. The green - around $1.40 - is the obvious buy zone.
The amber area - between about $1.63 and $1.70 has been a barrier, either one of resistance during times of pound weakness, or support during times of strength.
The green zone survived the aftermath of Black Wednesday, George Soros's raid on the pound and its withdrawal from the European Exchange-Rate Mechanism in 1992/93. It survived the repercussions of the dotcom crash in 2000/01. It even survived Gordon Brown and the stock market crash of 2008/09. Based on the evidence of the last 27 years, it's not easy to push the pound much below $1.40.
In fact, the only time this green area hasn't held pre-dates this chart. It was in 1984-85 during the unrest of the miners' strike. The pound had been wavering just below the $1.40 mark for several months when, in late June 1984, it slid below. It made its way lower for a period of several months, before reaching an eventual low of $1.04 on February 26, 1985.
By the following July it had made it back into the green zone, where it meandered upwards until 1986, when the chart above begins.
I therefore suggest that, for that 90c target to be reached, we need some fairly historical domestic unrest and upheaval to trigger it. It's not as though there's a shortage of potential sources of this. Increasing tension over government cuts could easily boil over and morph into something bigger.
But something on the scale of the confrontation of 1984-85? I wouldn't bet on it. Not just yet, anyway. This government tends to back down and pander in the face of confrontation in a way that Margaret Thatcher, rightly or wrongly, never did. Its strategy has proved to be one of can-kicking.
Sign up for a 3-week FREE trial of MoneyWeek
and get the following free as well
"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd
So where will the pound fall to?
But what about that green zone - the $1.38 to $1.43 area? Can we expect the pound to slide to there? That I would suggest is rather more likely, although by no means a done deal.
Here is a chart of the pound since late 2008. I have drawn in blue a trend line of the crash lows. We are sitting on that trend line now. It may well bounce from here.
The hammering it has taken this last month is not so unusual. It took a similar beating in May last year and in August-September 2011. On both occasions it found support in the $1.53-$1.54 area.
Based on the range of the last two years, it's likely it will do so again. In fact the range is pretty well established. Look to sell the pound around $1.63, or perhaps a little higher, and buy it back at $1.53.
However, if the red zone above does not hold - and I guess it would take some bad news, or rather the rumour of bad news – we could go a lot lower. I say rumour, because this current slide has been driven in part by the threat of various ratings agencies back in December to downgrade the UK's credit rating.
Indeed, you might find that in the event we are downgraded - should the pound already be down in the dumps - that it actually rallies, true to 'buy the rumour, sell the news' form.
So my prediction is this: sterling will fall a little more in the short term, but not as far as the bears might think. For now, that red zone will hold. It will continue to trade within the range it has established over the last couple of years. The currency is badly flawed, yes, but so is every other currency - which means there is a limit to how far it can fall against them.
For that red zone of support to fail, some kind of proverbial needs to hit the fan, I would suggest. But let's face it, there's no shortage of proverbial floating about out there! So while my advice to shorter-term traders is that the red zone might hold for now, I can certainly see it being shattered in the longer term.
My colleague John Stepek has more on the currency wars in general in the next issue of MoneyWeek magazine, out on Friday.
Follow John on Twitter || Google+ John Stepek
• This article is taken from the free investment email Money Morning.
Sign up to Money Morning here .
Our recommended articles for today
A wave of foreign investment has been lured to Southeast Asia on the back of increasingly open business practices. That's created a wealth of opportunities for investors, says Lars Henriksson.
Social networking websites still have the power to enthral investors and users alike, says Tom Bulford. That's something this builder of niche networking sites knows all too well.
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.