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Currency changes have a big impact on share prices

Electronic currency exchange notice board with several currencies listed.

For essential goods, the overall impact may be limited as importing companies and consumers have little choice and need to keep buying regardless of price considerations. This could be the case for key commodity inputs which cannot be sourced elsewhere.

Other companies will be much more vulnerable, especially in the case of luxury goods or where it is easy to find substitute goods.  In these circumstances, there is a higher risk that sales will decline in response to higher costs.

Burberry, for example, is a UK luxury brand with big sales in China. The People’s Bank of China pushed the yuan lower in August 2015 with USD/CNY strengthening to 6.40 from 6.20 while there were further gains to 6.60 in early 2016.

There were concerns surrounding weaker Chinese demand and there was a direct impact in raising the cost of Burberry goods in China. Fears over a negative impact on sales and earnings pushed the Burberry share price lower with a decline of close to 32% from the end of July 2015 to early January 2016.

Earnings effect also important

The second important factor comes in from the translation effect on earnings depending on where a company is listed. This is particularly important for the UK market given that a large number of companies in the FTSE 100 index are international companies.

In the mining sector, for example, companies are global in nature, but listed in the UK market. These companies also primarily sell commodities which are priced in dollars and their earnings are also denominated in dollars.

With the companies reporting in Sterling terms, there will be an important impact on earnings in Sterling terms and this factor also has an important impact on the share price.

If, for example, a company has profits of $100mn in a year, the Sterling valuation before currency depreciation would have been £67mn. If GBP/USD falls sharply to 1.25 from 1.50, the Sterling valuation of earnings will increase to £80mn.

There will, therefore, tend to be an increase in the valuation of shares based on current earnings and expectations of higher earnings over the medium term.

For example, Rio Tinto’s share price was trading at £2,090 immediately ahead of the June 2016 UK referendum on EU membership. The company has Sterling revenues of less than 1.0% with most earnings dollar dominated.

The share price rallied 10% in the week following the referendum vote as Sterling declined sharply. There was a net gain of 67% following by the middle of January when GBP/USD declined to the 1.2000 area.

The FTSE 100 index 22.6% from after the EU referendum until early 2017 with gains for internationally-based companies a key element in the gains.

Keeping up to date with the market

One very good way of keeping up to date with the markets and get a notion of what they entail for the future is using specialised currency brokers like OFX. Once you register (for free) you will be assigned with a currency trader which can keep you up to date on the market movements upon request. This is a free service, as these specialists will eventually turn profit you were to use their currency transfer functions.

Another option is to use a technological platform like Currencyfair. There, you can set up limit orders in a currency marketplace.

Sam

Director & founder of @CustardMedia; an online marketing and SEO agency. As seen in @marketingprofs, @prweek and @smbizceo.

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