Why buy the GBP?

The long-term picture

After having fallen to less than 1.4000 against the USD in September and November 2000, the Pound made another dive to 1.3678 in June 2001. From this day on, the Pound started to recover, only to test the 1.4000 support once more at the beginning of 2002. The GBPUSD rate remains since in a long-term UP-trend, pushing against the resistance around 1.6000.

The medium-term picture

By July 2002, the recovery of the Pound lead to a temporary high at 1.5864 when a consolidation set in which is not yet concluded although this high was exceeded last November to touch 1.5966. Nevertheless, medium-term, the GBPUSD exchange rate remains it an UP-trend.

We believe that the strong resistance zone around 1.59 to 1.60 will eventually give way while the USD remains fundamentally overvalued.

The short-term picture

Short-term trend, the GBP remains stuck in a consolidation process, digesting the advance from 1.40 to 1.59. We expect the minor support around 1.54 to hold and anticipate an initial move towards the resistance level. Whether the next attempt will be successful, we do not know, but we think that the break to levels higher than 1.60 will eventually occur.

Fundamental Considerations: The USD may be losing its Magic

• On the basis of a fundamental currency model, the GBP is still undervalued by around 30 %. The short-term goal during the coming two years is around 1.25 to 1.30 US dollars to the EUR. The flow of capital between the Eurozone and the USA for investments like equities, corporate bonds, government bonds and money-market securities will be reversed in the direction of Europe. It is believed that the projected relative development of fundamental evaluation factors - including growth potential, equity-market analysis, levels of return, inflation potential and budget deficits - is uniformly in favour of the old continent.



• Classic exchange-rate theories involving purchase-power parity and interest-rate parity also indicate a 25 to 30 percent upward valuation of the EUR. Many players in the market still give these theories a great deal of credence.



• The high levels of the US current account deficit during the past 10 years have entailed a large number of foreign central banks piling up big US dollar reserves. Asian central banks could trigger a severe currency crisis if they substantially reduced dollar positions and purchased EUR with a view to diversifying their currency risks. The German Bundesbank is also still managing big US dollar reserves, a major proportion of which are likely to be sold during the next few years, because they have become largely superfluous since currency reserves have been transferred to the European Central Bank. The current situation recalls the position at the end of the Bretton Woods System in 1973 when the world was also swamped with dollars due to the US trade deficit, and the central banks finally resorted to gold in order to spread currency risks.



• The high levels of the US current account deficit during the past 10 years have entailed a large number of foreign central banks piling up big US dollar reserves. Asian central banks could trigger a severe currency crisis if they substantially reduced dollar positions and purchased EUR with a view to diversifying their currency risks. The German Bundesbank is also still managing big US dollar reserves, a major proportion of which are likely to be sold during the next few years, because they have become largely superfluous since currency reserves have been transferred to the European Central Bank. The current situation recalls the position at the end of the Bretton Woods System in 1973 when the world was also swamped with dollars due to the US trade deficit, and the central banks finally resorted to gold in order to spread currency risks.



• The key fundamental factors have been indicating a drastic devaluation of the American currency for years. However, for some months now investors have also been receiving clear signals based on chart data indicating that the dominance of the American dollar is now history. Taking a perspective of a few weeks, the US dollar could win back some ground, but long-term analyses show charts tracing out clear top formations for the Greenback.



• The influence of political statements on the currency markets is waning. Negative statements by the US Treasury Secretary Paul O'Neill and Federal Reserve Chief Alan Greenspan led to big markdowns in the common European currency during the past two years. But then the European Central Bank had a low standing. Their interest-rate decisions were subject to vehement criticism not least in media biased towards America, while praise was heaped on the measures taken by the Federal Open Market Committee. However, it is believed that the stabilizing policy of a relatively calm hand at the European Central Bank will have more success over the long term in financial markets than the frenetic policy of the American central bank with its repeated and abrupt changes in direction. The first indications of a change in sentiment are already perceptible. When Treasury Secretary O'Neill emphasized the policy of a strong dollar in April of this year, the currency markets failed to fall in line for the first time. The EUR gained more than a cent during the speech because a large number of players in the market obviously regarded this policy as untenable in the long-term.

Currency Trading

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The following recommendations were valid at the time of writing, viz. at

and not necessarily when you happen to read them.

Yours sincerely,

Peter Zihlmann
www.pzim.com
forex@pzim.com

December 6, 2002