Before we begin today’s piece, a quick reminder for those who might find themselves in the Scottish neck of the woods this August, I am doing a show at the Edinburgh Fringe all about gold.
It’s from August 4th to 20th at 2pm. Please come if you are in town- you can get tickets here.
Plus an added bit of history: it takes place in the room in which Adam Smith wrote Wealth of Nations. Hopefully, I will see you there.
So, the pound …
An alert just went off in my calendar: “start looking to short the pound”, it says.
Why would one short strength?
Look at the pound these last few months, it has been very strong, very strong indeed. You wouldn’t know it to listen to many financial commentators, who so often seem consumed with national self-loathing, but against a basket of foreign currencies, the pound actually flirting with six-year highs (it’s got a bit further to go against the euro and the US dollar, though, largely, we tend to think of pound-dollar, aka cable, as the defining measure).
Charlie Morris of Bytetree argues that the pound has become the carry trade. (When you borrow at a low-interest rate in one currency and invest in another currency at a higher rate of return).
We are in an equities bull market of sorts, and the pound, as the currency of a nation geared to finance, tends to be strong when financial assets are strong. During times of financial crisis, it is much weaker.
Whatever the explanation for recent pound strength, I set the alert some three or four years ago - before the strength kicked in. What was I thinking?
It’s based on a cycle I’ve identified. As far as I know, I’m the first to observe this cycle, so, with Brand Frisby in mind, I’ve named it after myself: Frisby’s Flux - the eight year cycle in the pound.
Before I explain the cycle, let me issue a disclaimer. As outlined last week, it’s easy to look back at history, find some arbitrary pattern and declare it a cycle. Real life in real time is often a very different matter. Nevertheless, cycles can help frame where we are in the grand scheme of things.
My observation is that every eight years, the pound seems to crash.
We start in 1976, the year of the IMF (International Monetary Fund) crisis. At one point, inflation reached 24%. The Labour government borrowed $3.9bn, at the time the largest loan ever requested. From high to low, sterling lost around 40%, reaching $1.60.
But it recovered. By the early 1980s sterling was back above $2.40.
Then came the next bear phase, in which the pound would drop by more than 55% and reach an all-time low against the dollar – $1.04. This was the era of the Falklands War and then the miners' strike. The low came shortly after 1984, in early 1985.
On the other side of the trade, the US dollar was showing extraordinary strength – so much so that France, Germany, Japan, the US and the UK eventually colluded to depreciate it. This was the Plaza Accord of 1985. Again sterling would recover – this time to $2.
Eight years on, in 1992, sterling hit another significant low. This was Black Wednesday, when the Bank of England took the UK out of the European Exchange Rate Mechanism (ERM). It fell from $2 to $1.40 – a 30% loss. The killing that George Soros made selling the pound sealed his reputation.
Eight years later, around 2000, as the dotcom bubble collapsed, so the pound lost 20% of its value. (What did I say about the pound being geared to finance?). But again it recovered. By 2007 it was above $2.10. Can you imagine? The pound above two bucks only 16 years ago.
Then we got the financial crisis of 2008 and, yup, the pound lost 35%, hitting a low of $1.36.
The next low came in 2016 with Brexit then the infamous Flash Crash of 2016, shortly after Theresa May's speech at the Conservative Party Conference. Having been above $1.70 at one point earlier in this cycle, it hit a low of $1.14, according to some measures. The overall drop from high to low was almost 35%.
The subsequent bull market was probably the limpest in living memory. The 2016 low was retested in the Corona panic of 2020, but then we get a good rally to $1.42 by summer 2021.
After that, with so much political upheaval, the pound turned down. When the Bank of England broadcast that it would be selling the UK gilts it had printed the money to buy during Quantitative Easing, and Chancellor Kwasi Kwarteng then gave us his low-tax budget, panic hit the markets and the pound hit an intraday low of a $1.04 (the same low it hit in 1985). Since then we have had quite some rally.
Here’s the illustration of everything I’ve just described. Don’t you love charts? They get to the point much quicker.
Did the 8-year cycle low come early? Was that it in 2022? Or can we expect it some time in 2024?
When I first wrote about Frisby’s Flux, as long ago as 2017 it may have been, I suggested that we should be looking for a high some time in 2022-2023, as an opportunity to go short. Hence why I put that notification in my calendar. This current rally might be providing us with just one such opportunity. Question is: how long does the rally go on?
On a long-term basis, the pound at $1.28 is not exactly hugely overvalued. On a Big Mac Index basis (which measures relative currency value around the world based on the cost of a Big Mac) we are not far off fair value. As I say, cycles are easy to identify in the rear view mirror. They are much harder to trade in real time.
Perhaps the trigger will be yet more dysfunctional politics. Perhaps the Bank of England will fall even further behind the inflation curve and rates will spike, triggering some kind of crisis, such as we saw in the lead up to 1992. Perhaps equities more generally turn bearish. We can only guess what the trigger might be. But Frisby’s Flux, whatever it is worth, and that might be very little, is suggesting there might soon be an opportunity to go short the pound looking for an eventual low in 2024.
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