Britain’s referendum on whether or not to remain a part of the European Union is expected to cause something like a tsunami through financial markets – particularly if the ‘Leave’ vote prevails.
But what does that mean for Australia, or your personal wealth?
It is a hugely complicated question, especially over the long term.
For instance, a ‘Leave’ vote could encourage a wave of similar movements across the EU and permanently depress the value of the euro.
That might sound like ‘cheap Parisian holidays!’ to some, but the long-term reality is that Europe has been the biggest importer of Chinese goods.
And yep, those goods are often made with materials or energy resources exported from Australia.
That is not to say a ‘Remain’ vote would necessarily be different. The referendum is a reminder of the massive failings of administrative and monetary union across the EU – the euro and the pound could tumble together.
Our Asian trading partners could be severely impacted by the June 23 referendum.
The economies of south-east and east Asia, including China, are brimming with corporate debt which, like a house of cards, could tumble if the Brexit shock is severe enough.
Corporate debt defaults, when precipitated by a single shock, tend to spiral out of control and quickly land on the desks of bankers.
Those bankers become increasingly distrustful of other bankers, and the interbank lending that underpins all other lending can grind to a halt – and with it borrowing, investment and growth. The Brexit shock could leave our major export customers with empty pockets.
Whatever the long-term fallout for world markets, there are two short-term opportunities for investors who follow the contrarian advice to ‘buy on the sound of cannons, sell on the sound of trumpets’.
The currency play
The first is sharp movements on currency markets. A word of warning though – currency movements can be extremely hard to pick, and investors who get it wrong could lose a lot.
The most likely outcome from a period of Brexit-induced volatility is a lower dollar.
In recent weeks, the most bearish view is that the Aussie dollar could fall to 40 US cents.
More moderate forecasts have the dollar landing somewhere around 65 cents, though British bank Lloyds has gone out on a limb to forecast 77 cents by the end of this year.
But if you believe the mid-60s consensus, the way to profit from a fall in the dollar is to buy unhedged foreign currency denominated assets, and sell them again when the dollar is lower.
The most likely assets are gold, foreign shares (especially American) or even US dollars.
Some super funds offer investment options that offer exposure to these assets – at the click of a button, an investor can switch into them. Be warned, however, that such orders can take several days to execute.
Outside of super funds, investors using trading platforms operated by the big banks can buy direct exposure to US shares, currencies and even more complex products such as exchange traded funds and derivatives – all beyond the scope of this column.
Since the financial crisis, an increasing number of investors have worried about capital preservation rather than increasing their market risk in order to generate high returns – and so it would only be investors who are sure the dollar going to fall in the months ahead who’d be shipping their money offshore.
The risk-off play
The second way to profit from Brexit volatility is to bet that money will flood into safer assets – cash, certain classes of bonds and gold in particular – and out of ‘risk assets’ such as shares.
In this kind of speculating, the investor can take a position entirely through Aussie-dollar denominated assets – Australian shares, bonds and AUD-hedged gold.
So if an investor wanted to bet there’d be a sell-off of Aussie shares, all they need to is sell their shares ahead of a stock market tumble, and then buy back exposure to shares at a lower price.
Again, most super funds offer the ‘cash’ option, as do all online trading platforms. With the latter, you start your account with ‘100 per cent cash’ and then proceed to buy and sell assets with it.
History sometimes repeats
A final warning for anyone thinking of playing the Brexit turmoil – the institutional investors who trade huge volumes of money may not be shocked at all by either a ‘Leave’ or ‘Remain’ vote.
When terrorists flew passenger planes into the World Trade Centre in 2001, for instance, markets dropped like a stone. But when the Paris terror attacks took place last year, traders shrugged off that tragic news and markets were steady.
So if all the above looks a bit daunting, mum-and-dad investors wanting to profit from the Brexit vote would be well advised to take $50 down to their local betting shop.
At the time of writing, prevailing odds say that your $50 would become $77 if Britain stays in the EU, and $140 if it leaves. That’s a profit-and-loss equation that will make the news more interesting, without decimating your life savings.