Why you should keep avoiding banking shares

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If you needed any more proof as to why you shouldn’t buy banking shares just now, yesterday provided it in spades.

Shares in HBOS (HBOS), the UK’s biggest mortgage lender, took an early dive of 17%, apparently on an unfounded rumour, spread around the City by email, that it was trying to hold an emergency meeting with the Bank of England this weekend. Other banking shares quickly plunged in sympathy.

It wasn’t true, and HBOS denied the rumour categorically, as did the Bank of England. The shares recovered somewhat, but still ended the day down 7%. The Financial Services Authority said it is investigating, and looks set to come down hard if it finds any evidence of malicious intent. Some reckon that one or more traders with short positions may have spread the rumour to profit from the falls.

But the FSA may have a hard time. After all, the very fact that this anonymous email could cause such havoc shows how fragile confidence is in the banks. Being short financials certainly looks a far more sensible position for now than being long…

Hedge funds and short-sellers are going to come in for a lot of flack after yesterday’s share slump in HBOS. And it’s true that in such a febrile atmosphere, spreading false rumours is dangerous, frankly, and something the FSA should be watching out for.

At the same time, short-selling is a perfectly legitimate activity. And it’s perfectly rational to be short the UKbanking sector. Just a year ago, the idea that you could spark a double-digit fall in the shares of one of the UK’s biggest banks simply by sending an anonymous email round a few trading desks would have been ridiculous.

But then, a year ago, the idea of a run on a British bank – even a jumped-up bit player like Northern Rock – would have been laughable. Now we’ve seen the demise of a venerable Wall Street institution too, no one seems safe.

And like it or not, there are good reasons to be concerned about our banks. Earlier this week, we held our usual monthly RoundTable meeting, and everyone there believed that shareholders in UKbanks are likely to be wiped out by the time this financial crisis is done with, due to fund raising, government interventions, and whatever else it takes to prop up their balance sheets. It’s happened before, in Japan, not more than two decades ago, so it could happen here.

Banks: guarantees for savers, not shareholders

To make it clear – there was nothing to the rumours over HBOS yesterday. And if your savings are with a bank (or building society – they all rely on external funding to some extent), then the reality is that as long as you don’t hold more than the guaranteed £35,000 with any one institution, you should be safe – I wouldn’t be queuing round the block to pull out your money on the first sniff of a funding rumour. Northern Rock showed that the Government will not let savers (ie voters) lose their money – that really would cause a meltdown in the financial system. And having been through Northern Rock, I suspect the next crisis (and there is likely to be another one) will be dealt with far more swiftly.

But as Northern Rock also made plain (and Bear Stearns even plainer), when it comes to shareholders, there’s no such guarantee. In short, I might be happy to keep my money in a bank for the moment, but I wouldn’t be happy to invest in one.

The UKbanking sector hogged the headlines, but it wasn’t the only sector experiencing carnage yesterday. The Dow Jones ended down nearly 300 points as investors sold off following Wednesday’s 400-point leap. Meanwhile, more evidence that things are nowhere near normal with the financial system came as the commodities sector saw a mass sell-off, with everything from gold to oil to wheat taking a dive.

This is partly a rush for cash – hedge funds and other players selling off their most liquid, most profitable plays to raise the money to cover margin calls (where lenders ask for more money to cover losing positions, basically). But we’ve been saying for the past few months that oil and base metals would probably be in for a tougher year; and while we like the look of some softs, my colleague Dominic recently warned here that wheat looked like a classic bubble ready to pop (see: Wheat’s biggest bull market could be about to end badly).

Time to lock in some mining sector profits

The reality is that, while demand from China and India and other emerging markets will continue, the commodities market can’t simply ignore a recession in the US, which is, after all, still by far the world’s biggest economy. The USconstruction industry is in the doldrums – if Americans have too many houses, that strips away demand for an awful lot of raw materials.

The commodities sector will remain volatile for some time I imagine, but I would repeat what I said here a month or so ago – now’s probably a good time to lock in some of your mining sector profits. We’re heading into very uncertain territory for the global economy, where capital preservation will be more important than capital growth.

One exception to this, of course, is gold. As a classic safe haven, a long period of instability should see further new highs for the yellow metal. The recent plunge back to below $950 an ounce could well be an excellent buying opportunity. For more on how to invest in gold, see: Investing in gold.

That said, once we’re through the turmoil there should be some excellent buying opportunities. And if you’re the kind of investor who’s happy to buy now and sit tight, there may already be some good opportunities available. Stephen Bland certainly thinks so – his new high-yield portfolio newsletter will be launching next Thursday, and I know a lot of you have been looking forward to hearing what he has to say. For more information on how to sign up for Stephen’s first issue, click here: The Dividend Letter.

Turning to the wider markets…

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HBOS falls on bail-out rumours

In London, the FTSE 100 index closed down 60 points, at 5,545, after a volatile session. HBOS was the biggest story – and the biggest faller – of the day, accompanied by a bevy of mining stocks including Lonmin and Vedanta Resources. For a full market report, see: London market close (/file/44065/london-close-miners-drag-footsie-under.html

Elsewhere in Europe, the Paris CAC-40 was down 24 points, at 4,555. And in Frankfurt, the DAX-30 closed down 32 points at 6,361.

On Wall Street, commodity stocks led the major indices lower yesterday following a warning from the Fed to speculators. The Dow Jones lost 293 points to end the session at 12,099 as all stocks bar Coca-Cola went into the red. The tech-rich Nasdaq was 58 points lower, at 2,209. And the broader S&P 500 was 32 points lower, at 1,298.

In Asia, markets tracked Wall Street lower today, with commodities stocks bearing the brunt of the losses. The Hang Seng was down 758 to 21,108. Japanwas closed for a holiday.

Biggest one-day losses for oil since 1991

Crude oil futures fell almost $5 to close at $104.48 in New Yorkyesterday, and were even lower – at $98.06 – this morning. In London, Brent spot was at $99.75.

Spot gold was also a victim of the commodities rout, falling to its lowest level in a month – $920.30 – today. Silver, meanwhile, slumped to $18.12 an ounce.

In the currency markets, the pound hit an 11-year low on a trade-weighted basis this morning, although it had since edged up to $1.9825 against the dollar and 1.2770 against the euro. And the dollar was at 0.6439 against the euro and 99.74 against the Japanese yen.

And in Londonthis morning, Bank of England monetary policy committee member Kate Barker warned that house prices would fall this year but, due to credit conditions, ‘affordability would not improve’. She also predicted ‘significant falls’ in residential construction.

Our recommended articles for today…

Is it time to go contrarian on gold?
– Back in 2001, the idea of buying gold was met with almost universal derision, says Merryn Somerset Webb. Suddenly everyone is recommending it as the best insurance against horrible things happening in the market. Does that mean it’s time to sell? To find out what Merryn thinks, click here: Is is time to go contrarian on gold?

Why we should kill off these small stocks
– Many AIM-listed companies are frustrated by investors’ indifference, but the solution to their problems is rather an unpalatable one. Tom Bulford explains why it’s time to cut out the dead wood to restore AIM’s repuation, here: Why we should kill off these small stocks