If you're contemplating the possibility of a Eurozone meltdown, you might consider this .....

If you're contemplating the possibility of a Eurozone meltdown, you might consider this .....

ref :- "SMART MONEY" by Miles Johnson , The Financial Times, Markets and Investing

You don't have to be a political or economic analyst to be aware by now that upcoming elections and the rise of anti-euro, anti-immigration populist parties in the Eurozone are a combination that represents a significant danger for the future of the common currency (and conceivably for European Union itself). A narrow win for the mainstream in Austria last month may have given some comfort to Brussels and led to currency traders treating the euro with remarkable equanimity so far this year, but there are still big electoral hurdles to be overcome in the Netherlands, France, Germany and possibly Italy.

Like those currency traders, we have to keep things in proportion ..... populist wins in those countries are certainly possible but still considered unlikely. Of course, after the events of 2016 it's a moot point just how much comfort should be gleaned from the experts' predictions. But likely or not, every money manager has a duty to consider how best to protect his portfolio against any development that COULD spell the demise of the euro.

One might imagine that hedging such a risk might involve some pretty complicated strategies, too sophisticated for easy comprehension. No doubt there are plenty of such schemes in place, but Miles Johnson offers a slightly more straightforward solution : BUY GERMAN BUNDS and ...... er, that's it.

Well, we all like "simple" but can that really be it ? Buying a 10-year German government bond with an annual yield of just 0.3% (say) might make sense if you believe that yields are headed lower (and therefore prices higher), but taken on its own such a move hardly seems the most attractive investment advice. Especially when Trumpflation trades have been boosting yields and depressing prices on US Treasuries and global bond markets generally.

You have to remember that in this instance buying Bunds is being recommended as a hedge against a break-up of the euro and the intention should be to hold on them until maturity. An annual return of .03% is not very exciting but does mean that you will get your investment back in one piece while still receiving some income and protection for 10 years. Contrast this with other strategies, which might normally involve purchasing currency options. This would require paying expensive premiums which would naturally lose money through time decay if nothing happened (and ultimately they would be abandoned, worthless).

So in that scenario you have a hedge that maintains its value and actually pays you money on the one hand, and one that gradually diminishes to zero value on the other. But it's if the unthinkable does come to pass that buying Bunds really comes into its own as the most effective way not only to hedge risk but also to profit outright from the break-up of the euro.

Just about the only certainty should that happen is that the resulting new German currency (Mr Johnson calls it Deutschemark 2.0) will be worth a lot more than the now defunct euro. Germany is sincere in its decrying of ultra-low interest rates in the Eurozone, but the fact is that the resulting weak currency gives a huge advantage to a successful trading nation like Germany. The German current account has benefitted enormously from what for them is an artificially weak currency, and their surplus has strengthened relative to that of the US. Any new German unit should trade at a significant premium to the euro when priced in dollars ..... and therefore German government debt re-denominated into that new currency will appreciate in equal measure.

You have what's known as asymmetric risk : if the euro should cease to exist, your German bunds will show a big increase in value, but if the worries turn out to be misplaced then you still earn a little bit from your hedge  -- PROVIDED that you hold on to them until maturity. How bad is that ? It's both dead simple and seems to make perfect sense, and as hedges go it would seem to have a lot going for it.