Why do people buy or sell currency at the wrong time?

There are many books written on why investors, when investing in shares, can find it impossible to realise their losses when the share price goes down. There seems to be a big psychological barrier - which means that hope takes over from common sense or good investment practice – and, they believe that the share price will recover to at least the price they bought the share at, and so they will not “be out of pocket”. In fact, a good investor will sell the share, put the loss down to experience, and look out for a new investment on which they expect to make profits. It should be remembered that a good investor could well lose over 50% of the time - but being savvy, they would run their profits, close out their losses and therefore make profits overall.

When it comes to buying currency, even though the process is different, the same psychology seems to apply. We spend a great deal of time talking with our clients and trying to get them to understand the effect of a currency moving against them. If it does, then additional funds would be needed for the buying of overseas goods. Or, the company may get less income than expected for those all important overseas sales and the effect of either on the company would be to reduce profitability and reduce positive cash flow. And, if it was for an individual, it could mean finding an extra £10,000 at the last minute for their dream overseas property - and this could be a somewhat painful experience.

Recently, a client was looking to buy US$’s as he was importing a new range of giftware from China. When we first discussed his requirements with him, the US$ was over US$1.65/£1. He was committed to the purchase of just under US$100,000 of goods, but he was unsure of timing. We went through the advantages of using a forward contract but he had budgeted a rate of US$1.68/£1 and he thought sterling, based on some pundits forecast, was on an upward trend.

15 years plus in the foreign exchange industry has taught me very clearly that no-one can really forecast where an exchange rate is going to go. Only very rarely is it plainly obvious, as when Northern Rock went bust and there were long queues standing outside the branches desperately trying to get their money.

My thought process and discussions with the client were to hedge at least 50% of his requirement at US$1.66/£1. This would reduce the downside risk and allow him to benefit if the exchange rate improved. The trouble was, his budget and his “hope” that the forecasters were right. Yes it would have locked in an increase in cost of just over 0.5% but he would have reduced the downside risk.

So what was the final outcome? Sterling didn’t continue its upward trend because sterling has few friends and any bad UK news tends to be sterling negative. He finally placed a forward contract just above US$1.63/£1 for the full amount. So, against his budget, he “lost” 3% and compared to what he could have bought the currency the first time I discussed the purchase, he lost just under 2%. Thankfully, not disastrous - and not as bad as if he had left the exchange to where the US$ is now [under US$1.60/£1]. But why take the risk and increase the stress when recent history shows how quickly exchange rates can move against you?

The other thought is that he should have been more careful in his budgeted exchange rate. The rate was simply too optimistic given sterling’s history. I always tell clients to work with a conservative exchange rate as this will allow you to plan with some upside - and it’s always nice to have an upside. Having been a finance director of a mining company working on three different continents, I quickly learnt the benefit of doing this as being over optimistic on an exchange rate could have a very nasty effect on cash flow. And, I quickly learnt the benefit of placing forward contracts - because when you deal with the sale of commodities, any change in exchange rate can be measured in £100,000s.

And one final thing I would mention is an “order to call” or an “order to buy”. With these you set a target rate at which you are willing to buy. When the target rate is hit, the funds are then purchased [or we call you to confirm the order] and if made with a currency specialist like ourselves, this order can be placed overnight, so if the rate is triggered somewhere in the world, you get the rate you want. Very simple and removes the strain and stress.

I know human nature is difficult to overcome, but by careful thought and planning, a lot of problems can be avoided when it comes to currency exchange. In certain instances, it isn’t just problems that can be avoided, it could actually be extreme pain if it is the difference between a highly profitable contract and a significant loss making contract.

For information on how Smart can help your company, please go to: www.SmartCurrencyBusiness.com

January has been an interesting month for the UK economy. The first few weeks reported:

• better than expected year-on-year sales growth to December (6%)



• positive unemployment data



• a key member of the Bank of England stating that the Bank would look to raise interest rates earlier than initially expected as the UK was well on the way to recovery

The shift from a very negative outlook for the UK was clear as data continued to come in better than expected. A relatively large jump in inflation cemented this and when data demonstrated that prices had risen by 2.9% over the last year, sterling strengthened to hit 5 month highs against the euro and rebounding to early December highs against the US dollar. This was supported further when the Bank of England put on hold their programme of pumping money into the UK economy (quantative easing).

But just when we thought there was a light at the end of the tunnel…we turn to face more darkness. Sadly – all the good news and positive feelings came to a halt when the UK’s GDP growth of 0.1% for the fourth quarter of 2009 was announced.

Let’s look more specifically now at the euro: One of the major issues over the last few weeks has been the crisis in Greece and the other so called ‘Club Med’ countries of Spain and Portugal. Theses countries have come under severe pressure from investors and the markets to bring borrowing down and cut their respective deficits. With the prospect of no external help (until very recent rumours have started to spread) the euro has suffered and risk aversion has returned to the markets with many investors moving their funds to safe haven currencies such as the US dollar and Japanese yen. What’s this mean for you – keep reading…

Whilst the euro zone problems have helped keep sterling and the UK as a relatively more attractive investment against the euro (and subsequently maintain prices in the €1.13-1.14/£1 region), a side effect of those issues is increased risk aversion that has seen investors flock to the US dollar from sterling and causing the price to head towards US$1.50£1. So far this year, analysts expectations of €1.15 – 1.20/£1 for sterling are still on track, as are the expectations of US$1.50 – 1.55/£1. But like last year, the possibility that the exact opposite happens is quite high because as can be seen from the disappointing fourth quarter UK growth figures, the path to recovery here in the UK is going to be long and hard.

Time to buy, sell or hold tight on euros/ US dollars?
So – what should you do if you need to make a euro payment? If you are willing to take risks, you may be able to afford to hold off a little on euro payments and see how things pan out in Greece as the UK is much closer to raising interest rates than the Euro zone (which would see sterling strengthen).

However, with US dollar payments the sensible approach seems to be to take advantage of anything at the top end of the US$1.50/£1’s, as the US recovery storms ahead and risk appetite/ aversion comes and goes, and the market expects sterling to weaken off against the US dollar.

Do you need a live quote or more information on just how much Smart Currency can save your organisation? Call 0845 638 0571 or visit: http://www.smartcurrencybusiness.com/ now.

Feedback from Smart Business Clients
Excellent service was provided from day one from Smart Currency. The initial response to my enquiry was prompt, personalised and informative. Whilst I appreciate that Smart Currency have many business clients, I was certainly made to feel like their only one! An excellent, professional and personal service to be highly recommended.
NA

Your service has been excellent and we will certainly make our future international payments through your Company. Having never made payments with a currency specialist rather than our bank, we were a little nervous however, you always give us a competitive rate which on the amounts transferred has been quite a saving on the High Street Bank. Thank you.
KB

For more information on how Smart can help your business, call 0845 638 0571 or visit: http://www.smartcurrencybusiness.com/ now.

Jargon Buster: Volatility
The tendency of the price of a currency to move up and down by large amounts relative to other currencies. High volatility in the price of a currency means higher risk that the party making payments will lose large amounts as the exchange rate/price will have a tendency to make very quickly. E.g. John hated the current US dollar volatility as it meant he might not be able to afford his house in the USA.

Do you need a live quote or more information on just how much Smart Currency can save your organisation? Call 0845 638 0571 or visit: http://www.smartcurrencybusiness.com/ now.