Pound Gets Pounded into a Bullish Opportunity for FXB

03/30/2017 1:25 pm EST

Focus: CURRENCIES

Landon Whaley

Editor, Focus Market Trader

After this week’s official trigger to Brexit, there are no other concrete future dates for bad news. This should cause many bears to capitulate and buy the pound to close their shorts, asserts Landon Whaley of The Whaley Report.

Humans are innately flawed decision makers. Every part of your DNA hard-wires you to be an investing failure, which is why the behavior required for successful investing is counterintuitive. One such counterintuitive behavior that is absolutely critical to being consistently profitable is buying into markets that have been falling and remain weak.

Man, this is a tough one, isn’t it?

Other than a carny who makes his living entertaining people from town to town, who wants to be in the business of catching falling knives? Not me.

That said, the most profitable opportunities come when a beaten-down market begins to stack up bullish catalysts that go largely unnoticed by most investors. Right now, this dynamic is playing out in a market that has had a very difficult year: the British pound.

Divorce is Tough
The pound has been the kid stuck in the middle of divorcing parents for the last twelve months. On June 23, 2016, the UK voted to leave the European Union, in an epic win for the populist movement. That Friday, markets went wild, with gold and Treasuries ripping higher while equity markets got taken out back.

But the real loser in this divorce between the UK and EU was the British pound.

Prior to the referendum vote, the pound hit a three-year high. But in the last nine months it’s lost over 20% of its value, has officially crashed and is trading at the same price as when “Wall Street” hit theaters. Greed is good, anyone?

The pound has been range-bound for the last six months, largely due to uncertainty about how Brexit would officially move forward. Well, the uncertainty ended Thursday (March 30) when Prime Minister Theresa May formally notified EU Council President Donald Tusk that Britain really is quitting the bloc it joined in 1973. There is nothing the market hates more than uncertainty, and from a political perspective a major hurdle has just been crossed. But politics isn’t the only reason to like this trade market from the long side.

It’s Fundamental
For me, everything starts with a market’s Fundamental Gravity, which consists primarily of the trajectory of the economy and central bank policy.

Since Brexit, the doom-and-gloom crowd has been calling for the end of UK civilization. At some point, these folks need to put away their pitchforks and become data dependent, because the economic data continues to massively outperform expectations and, more importantly, continues to improve.

UK annual GDP growth has accelerated for three consecutive quarters and is now sitting at 2%. Both manufacturing and service sector data are sitting at levels well above their pre-Brexit levels.

It’s not just hard data improving, because so-called “soft” data has improved markedly since last June’s referendum. The UK ZEW Economic Sentiment Survey has improved in six of the last eight months and the Small Business Sentiment Index is at three year highs after accelerating for three straight quarters.

But improving growth is only one side of the economic equation; the other side is inflation.

All three key measures of inflation—core, consumer and producer prices—have been following the rest of the world’s lead and ripping higher. All three measures are now sitting at the fastest pace in over three years.

Improving growth and heating inflation have led to a hawkish shift in the Bank of England (BoE), where the majority of members are coming to terms with the need for a rate hike sooner rather than later.

More Shorts than Summer
The reason the pound looks even more compelling from the long side is that most people are either blind to or willfully ignoring the economic data and what it portends for BoE policy.

The amount of speculative short positioning in the pound is currently at an all-time high. In fact, the amount of money that is short the pound has exceeded $8B for the first time since data collection began in 1999.

This positioning has been massively tilted to the short side for months, and it’s only a matter of time before those historic positions unwind. For my money, the time for that unwinding is now.

After this week’s official trigger to Brexit, there are no other concrete future dates for bad news. This should cause many bears to capitulate and buy the pound to close their shorts.

As a result, the dominant fund flow in the coming weeks will be investors buying the pound, and there is a whole lot of buying to be done. Can you say “short squeeze,” anyone?

The Trade
For investors who prefer exchange-traded funds, ETFs, you can get long the British pound via the Guggenheim CurrencyShares British Pound Sterling Trust, FXB. You can initiate new long trade ideas at any price below $123.00. Depending on how much room to move you want to give this trade, you can use a risk price between $119.30 and $117.80. If FXB closes below $117.80, then you should exit any open trade ideas.

For many reasons, including liquidity and 24-hour trading, I prefer to execute currency trades using the forex market. If you are an investor who is comfortable with these types of trades then you can execute this long trade idea using the British pound-US dollar currency pair, GBP-USD. You can initiate new long trade ideas at any price below $1.2570. Here again, depending on how much room you want to give this trade, you can use a risk price between $1.2180 and $1.1940. If FXB closes below $1.1940, then you should exit any open trade ideas.

The Bottom Line
So much bad news has been massively priced into the pound that for the last few months it hasn’t been able to weaken further in the face of more negative news. Add to this fact a hawkish shift in BoE policy, political clarity and everyone and their mother leaning to the wrong side of the boat, and the scene is set for one hell of a rally.

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