How to Play the EU Referendum for Profit

The trend in politics over the past 20 years has been towards centralisation.

Central governments have gained more power at the expensive of regional and local governments. That’s hardly surprising as central governments have the biggest range of powers to levy taxes…and the greatest power to provide welfare.

Now, before you stop reading and change channels, we’ll assure you this isn’t one of our libertarian rants (we leave that for our new free eletter, Pursuit of Happiness). The reason we bring up centralised government is that one country appears to be on the verge of reversing that trend.

And it could present you with an outstanding investment opportunity

Yesterday, UK Prime Minister, David Cameron gave a long awaited speech on the UK’s relationship with Europe. In the speech he said:

 ‘The next Conservative Manifesto in 2015 will ask for a mandate from the British people for a Conservative Government to negotiate a new settlement with our European partners in the next Parliament.

It will be a relationship with the Single Market at its heart.

And when we have negotiated that new settlement, we will give the British people a referendum with a very simple in or out choice. To stay in the EU on these new terms; or come out altogether.

This could be the big story of the next four years (the EU referendum is due around 2017).

Forget the US debt and deficit troubles. Don’t worry about China’s booming or busting economy (depending on which of our editors you agree with, check out here and here). And as for Europe’s various problems — Greece, Spain, Italy, Ireland, France — forget about it.

Make no mistake, this is a huge story. And not surprisingly, the central planners don’t like it. As the BBC reports:

 ‘In Washington, the White House welcomed Mr Cameron’s “call to remain in the EU”, saying it believed that the UK was stronger as a result of its EU membership.

French Foreign Minister Laurent Fabius said a future for the UK outside the EU could be “dangerous”.

French President Francois Hollande was clear about his desire to see the UK remain an EU member…

German Foreign Minister Guido Westerwelle called for the UK to “remain an active and constructive” part of the EU.

But the biggest message from the Eurocrats is it’s clear they don’t like people having choice. Guido Westerwelle says ‘more integration’ would solve Europe’s problems and that ‘cherry-picking is not an option.

In other words, they want more centralisation and less choice.

So, what does this have to do with investing?

 When George Broke the Bank of England

There’s nothing big investors (and we mean BIG) like more than key events in highly liquid markets.

Big investors like these markets because of the amount of money invested. They also tend to be mature, and importantly, they attract sophisticated investment products. By that we mean derivatives.

Think about the stock market bubbles and crashes…think about the US housing market bubble and collapse…think about commodity market bubbles and crashes — gold, iron ore, and rare earths.

But also think back to one of the most famous investor attacks on a highly liquid and sophisticated market. We’re talking about billionaire investor, George Soros’ attack on Pound Sterling in 1992.

If you’re not familiar with the story, the short version is that the UK was part of the European Exchange Rate Mechanism (ERM). The ERM was basically a system where governments and central banks agreed to keep Europe’s various currencies within certain trading bands.

This would involve the central banks working together to buy and sell currencies in order to keep an exchange rate stable. For example, if the German mark was too high against the British pound, the central banks would agree to sell marks and buy pounds.

This agreement fell apart in 1992 when the UK refused to raise interest rates or devalue the pound.

Prior to this, Soros made a huge USD$10 billion bet that the UK would be forced to devalue the pound. It turns out he was right. Despite the UK Treasury’s effort to support the pound, the UK eventually withdrew from the ERM, the pound collapsed, and Soros bagged a USD$1.1 billion profit on his trade.

The mythology of the story is that he ‘broke’ the Bank of England. He may not have done that, but his profit wasn’t bad for a few months’ work!

Our bet is that the big hedge funds will start honing in on the UK economy and its markets. The only question is will they see a UK exit as good or bad for UK investments…

 Why the EU Referendum Will Drive UK Stock Market Down

With the EU referendum still four years away, it’s too early to think about making short term trading profits. Based on the reaction of the FTSE 100 yesterday, right now the markets think it’s pretty ho-hum. The FTSE 100 closed the day up 0.3%.

But even though the EU referendum is a long term event, it’s still worth looking at the market to figure out which way the big hedge funds will play it. And considering the UK stock market is now in ‘overbought’ territory (see Dominic Frisby’s article on the Relative Strength Index) placing a bet on the short side could be a winning trade.

The fact is, we’ve got no doubt that over the next few years the central planners and collectivists will paint a very grim picture of what life will be like for the UK outside the European Union…even though it did pretty well for the previous 900 years without European integration.

And with the next UK election due by 2015, it makes for a fairly unstable four years for the UK markets. That’s why we see the long term trade (2-4 years) for the UK as sell. Especially given the UK’s debt position and the threat to its AAA rating. As the Financial Times reported last December:

The UK’s prized triple-A credit rating could be set for the chop next year, as the big rating agencies reassess its finances…

Remember the most important thing, whatever the reality (we personally think the UK will be better off on the outside), the old stock market saying is ‘buy the rumour, sell the fact’.

Regardless of what really happens to the UK if it leaves the EU, investors in the market will make up their mind before it happens. And if the hedge funds and big investors have anything to do with it, that likely means striking fear into the market and driving it down.

So, how can you trade the UK? Unfortunately, the Australian share market doesn’t have any exchange traded funds for the UK stock market. So the best way to trade the UK is through Contracts for Difference (CFD’s).

Using CFD’s you can buy or sell individual stocks, or our preference is to focus on the index. That gives you the broadest possible exposure to any big bets the big investors may place on the UK economy.

Just be aware that CFD’s are highly leveraged, so they aren’t for everyone. Before you think about getting involved with them, check out the education section of the main CFD providers.

But whatever you do, keep an eye on the UK. Our hunch is that over the next couple of years it will surprise everyone and become the biggest talking point in financial markets.



From the Port Phillip Publishing Library

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Money Morning: Here’s Why I’m Proudly Bullish About China’s Economy

Pursuit of Happiness: The WEF: The World’s Biggest Gathering of Socialists, Collectivists and Central Planners

Australian Small-Cap Investigator:
Five Simple Steps to Picking Winning Small-Cap Stocks

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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