Don’t sit on the financial sidelines. Leave the stadium, or risk infection.

You’ve seen them on the news. The people ignoring social distancing.

I’m not sure what to make of it. It’s a bit like the hoarding. At first it looked stupid. But with everything sold out, perhaps it wasn’t so stupid after all.

Self-fulfilling prophecies are of course still worth preparing for. If you know people will hoard soon, in an irrational panic, doesn’t it make sense to buy before they do?

People who understood crowd psychology are wiping their bums with toilet paper. Virologists, academics, intellectuals, public servants and social media moderators are not.

Perhaps those busy infecting themselves with Covid-19 will be fit, healthy and immune soon, while those in self-isolation remain vulnerable in six months’ time…

Today, I’d like to look at financial distancing. How you can keep your wealth safe from the coronavirus crash. And the same principles apply.

Right now, those criticising the hoarders and brave (or ignorant) socialites are making a big financial mistake. From the sidelines, they’re criticising those still playing the game for ignoring the risk of infection. But they haven’t left the stadium yet.

That’s a garbled metaphor for my claim today. Your money is at risk, even if you’ve sold out of the stockmarket. And if you’re still considering your escape, you’ll want to know what I’ve got to say too. Unless you want to learn the hard way.

But first, a late entrant to yesterday’s Exponential Investor. Our value investing expert Tim Price sent me this in response to my emailed question: what will you be looking for to time the bottom in the stockmarket?

No one indicator will likely do the trick, and there will likely be lots of false dawns and torrents of wishful thinking before the low is conclusively in. That said, I would be looking at a number of things, including:

* A bottoming and sustained upturn in the price for copper (as one of the smartest industrial metals).

* A sustained rise in US Treasury yields (which would also indicate that the long-anticipated Great Inflation is beginning).

* New highs for gold in all currencies, including the US dollar.

* Japan’s Topix index conclusively turns a corner back up (Japanese companies have been dealing with grinding deflation for 20+ years and have been hoarding cash. They now have the healthiest balance sheets in the world. Compare that to the state of US Inc., where many companies will come to regret long years of share buybacks fuelled by debt.)

* Robert Peston is fired by whoever is dumb enough to be employing him in the first place.

As the above should indicate, not all markets and sectors are created equal right now. I would far rather own precious metals and precious metals mining companies than “the stockmarket” in general.

Inflation is surely coming, thanks to the Feds. And, as before, I would favour Japan and Asia (ex-China) over the rest of the world.

There will be leading and lagging markets in the turnaround from Covid-19. Understanding which are which could be the key to timing the bottom of the market.

And now, back to my metaphor. Those who believe they’ve retired to financial safety by selling their investments are still very much at risk. Holding the wrong type of cash could cost you dearly in this crisis.

And now, back to my metaphor. Those who believe they’ve retired to financial safety by selling their investments are still very much at risk. .

A few weeks ago, colleagues of mine in Australia swapped their pension accounts out of stocks and into cash. They didn’t want to spend their time watching markets at home as well as at work as the coronavirus collapse unfolded. Now they work from home, ironically enough.

This move to cash seems like a rather good decision, with the benefit of hindsight. But hindsight isn’t finished yet.

You see, cash isn’t what it used to be.

Cash used to mean physical gold or silver, in your hand. “Cash in the bank” would’ve been a paradox once. Unless you meant the safety deposit box.

You’d go to the bank to redeem your banknotes for cash – gold and silver. Cash was how you opted out of the banking system in case your bank failed, making the banknotes issued by that bank worthless. At that point, banknotes were promises from a bankrupt institution to pay gold or silver that it didn’t have.

When the government nationalised the money supply and issued its own banknotes, no longer backed by anything, cash came to mean physical banknotes. I’m not sure why we still call them banknotes given the government issues them, but never mind.

These days, to younger people especially, cash doesn’t mean anything at all. Nothing tangible, anyway. It’s just a digital number on a screen. Many young people don’t have a wallet, let alone banknotes in it.

What’s changed here is the ability of cash to deliver its opt-out from the banking system. If cash is a number on a screen provided by a bank, you can’t escape that bank any more. If the bank fails, well, you can’t really avoid it by being in cash.

Unless you hold the old cash – real cash. Gold, silver or banknotes.

But what is the risk to bank account cash anyway?

Well, in 2009 and 2013 the UK government created a rather extraordinary risk to digital cash in the bank. Particularly large amounts of it, as you might have if you’ve just sold your investments to escape the stockmarket crash.

The government’s own Impact Assessment explains:

The Financial Services (Banking Reform) Act 2013 (the ‘Banking Reform Act’) added a bail-in tool to the Special Resolution Regime (SRR) through amendments to the Banking Act 2009.

The bail-in option allows the Bank of England to resolve a bank or building society that is failing or likely to fail by writing down or cancelling certain debt liabilities and/or converting debt into equity.

In other words, if a bank is close to failure, the Bank of England can declare a bail-in. It’d convert deposits not covered by the deposit guarantee into bank shares to save the bank. The bank won’t owe you the money you kept there, in “cash”. Instead, you’d get shares in the bank. The deposit will be converted to stocks.

Those who sold their investments to sit out the crisis and held cash in the bank instead will be in for a shock if this happens. Hindsight will get the last laugh as stocks tank, but cash deposits are converted into stocks too.

Unless investors practice financial distancing in the 7 ways laid out here. By escaping the banking system, you can escape the bail-in too.

Let’s quickly glance at why the government created this risk to cash in the bank in the first place. The Impact Assessment continues…

During the financial crisis, the Government was forced to bail-out some banks at huge expense to the taxpayer and shared to some extent with the banking industry.

The bail-in tool provides a viable alternative, facilitating the resolution of a failing bank or building society without the need to use public funds.

In other words, 2008 cost the UK government taxpayers too much money. Someone else should pay. And depositors are on the list.

Because depositors aren’t the same people as taxpayers… and the public’s money isn’t public money…

If you have as little faith in the government’s ability to deal with a financial crisis as I do (you couldn’t have less), why not check out my advice for how to financially distance yourself here.

Don’t just sell your stocks and sit in cash at the bank. You might wake up to find it’s been converted to bank stocks.

Until next time,

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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