Brexit Crushes British Pound…
Gold is a worldwide reserve asset. We must increasingly expand our focus from not only what is happening here in the United States, but also toward the international dynamics which are at play across the globe. Although futures contract settlements and profits reported by mining companies are typically priced in US dollars, the long-term thesis for precious metals revolves around an international recognition that no central-bank created fiat currency is intrinsically more valuable than any other. Thus, at various times we expand our horizon beyond the shores of the northeastern United States. Following the broader perspectives on other reaches of the planet.
Let us turn to the United Kingdom. On Thursday of last week, UK Prime Minister Theresa May approached a summit of European Union leaders in Salzburg, Austria. This was in order to propose a framework for a “smooth” exit from the EU. This follows the British vote (“Brexit”) of June 23, 2016, in which the population decided by a 52% vote to leave the common European market. The UK is scheduled to officially leave the EU on March 29, 2019. This is unless some form of compromise between the two sides can be reached then.
According to multiple sources, talks at Salzburg reached a critical impasse during the late hours on Thursday. European politicians had rejected May’s proposal to retain a free trade clause after the UK officially leaves the EU in March.
May’s response to the negation was that it is “simply unacceptable” for the EU to reject her plans without offering an alternative. An impasse indeed.
When Will Gold Benefit?
Certainly, there is much occurring behind the scenes here that we are not privy to. However, our goal is not to try to over-simplify an incredibly complex set of issues. Rather, we want to focus on what the market’s reaction is to such international tensions, and what we may expect going forward based on the observable evidence from the markets themselves.
Below we show a cross-market reaction to the negotiation breakdowns from Thursday through the end of the trading week on Friday:
Note how the British pound (black) fell over 1.7% in the 12 hours following the negotiation breakdown.
The US dollar (green) rose slightly, although it did not receive a proportionate increase to the pound’s decline, gaining just over 0.3% from trough to peak.
The gold price as priced in British pounds (gold) received a partial safe-haven bid, rising 0.8% in the 12 hours following the meeting to close at £919 per ounce, yet still not matching the pound’s decline.
Finally, note how the London FTSE 100 stock index (blue) gained over 1.5% from trough to peak following the meeting.
Something will be amiss here unless we are willing to open our eyes to the facts as presented. Because this is so critical in understanding the market psychology as it presently exists, let us review the dynamics in sequence:
- Brexit negotiation breakdowns were perceived as negative for the British pound, falling over by 1.7%.
- For safety, pound currency holders moved slightly into US dollars and slightly more so into gold.
- Yet the clear leader for “British pounds seeking refuge from currency depreciation” was none other than the broad London stock market.
What is happening here?
If you have been following this series of articles for some time, you will know that we often make a differentiation. Usually between what we believe should happen and what actually is happening in the world around us.
What we believe should happen is that as all fiat currencies worldwide are depreciated simultaneously for the first time in recorded history, those currency holders should seek refuge in the longest-serving non-governmental store of wealth humankind has ever known: gold.
Yet what actually is happening presently is that currency holders are first seeking refuge through the broad national share markets.
This phenomenon was clear to see last Friday, as the London FTSE 100 rose nearly perfectly opposite to the British pound’s decline.
If the British pound lost 1.7% but the British stock market gained 1.5%, did stock investors actually gain purchasing power? Clearly, the answer is no.
However, did stock investors maintain purchasing power better than gold investors? Who gained only 0.8% over the comparable timeframe? The answer is yes.
Should it be this way? We can argue that British pound holders are acting irrationally. We certainly wish that pound holders were wise enough to purchase gold instead of index shares… but again: our wishes should not be the critical part of the equation.
It is more important that we focus on at this time on what is. This way, we can protect ourselves, and more importantly, prepare for when this gold price market psychology finally reverses.
The same behavior is presently occurring in the United States. We have covered in past articles (please view https://bullionexchanges.com/blog/2018/09/04/metals-suffer-president-trump-cheerleads-stock-market/). Referencing, how the US stock market is just beginning to enter a parabolic advance. Despite being overvalued by nearly all historical metrics.
Let’s admit it. Even by the US government’s own statistics, inflation is running between 2% – 3% per year (and actual figures are likely twice that). Does this mean the gold price must rise by 2% – 3% concurrently?
Certainly not. Many more factors are at play for the precious metals than a simple direct relationship between inflation statistics and gold price increases. Importantly, the market psychology itself is a critical determinant of where inflation refugees seek safety.
Pound Depreciation Flows Into Stock Market
At present, currency holders around the world are content to use the major stock exchanges as outlets for the consistent debasement of currency which is taking place every year. To some extent, there is merit to the strategy: for as a currency depreciates, the relative value of the real assets on the books of companies should be priced upward.
Real assets such as oil fields, land, mineral resources and agricultural products would be revalued upward amidst a depreciating currency. Certainly then, some percentage of the assets on major stock exchanges should be inflation-proof.
Then, when will the gold price finally shine? Only when the inflation becomes bad enough to impact corporate profits.
Generally speaking, companies cannot reprice assets quickly. A lag of weeks, months, or even years can occur between the time that a market is aware of inflation and the time that companies can impose price changes that can be passed onto consumers.
In a rapid inflationary environment, the gold price is easily repriced by the market at a moment’s notice.
Gold serves as the ultimate form of protection when inflation becomes so destructive that it is destabilizing to companies’ operations. Our estimate is that this destabilization begins to be felt when inflation exceeds 6% per year.
Takeaway on Gold and Brexit
The British stock market is serving as an outlet for depreciating pounds at present. Gold price is receiving a minor safe-haven bid. However, the psychology of the market’s focus is not cautious enough to see significant inflows into gold yet.
Still, a bit of one’s assets held in physical gold outside the banking system is recommended. As the ultimate hedge, should an unforeseen “black swan” event occur, sudden depreciations in major currencies have happened throughout past market cycles. All fiat currencies are suspect. It is simply a matter of timing the market’s focus on the severity of the problem.
We will continue to keep an eye out on this phenomenon, should the British pound weaken further to the March 2019 Brexit deadline.
BULLION EXCHANGES MARKET ANALYST
Christopher Aaron has been trading in the commodity and financial markets since the early 2000’s. He began his career as an intelligence analyst for the Central Intelligence Agency.
Christopher Aaron specializes in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq. His strategy has helped his clients to identify both long-term market cycles and short-term opportunities for profit.
This article is a third party analysis and does not necessarily match the views of Bullion Exchanges. Do not consider Bullion Exchanges as financial advice in any way.
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