Will ‘Brexit’ drive a new bull mar­ket in gold?

China Daily (Canada) - - LIFE -

The UK’s de­ci­sion to vote in fa­vor of leav­ing the Euro­peanUnion in a na­tion­wide ref­er­en­dum on June 23 has al­ready boosted the prices of pre­cious met­als. The prospects for both gold and sil­ver over the com­ing years are bright. Nonethe­less, Brexit alone­may not be the game changer for the gold mar­ket that many an­tic­i­pate.

The Brexit vote has led to a sig­nif­i­cant in­crease in eco­nomic and po­lit­i­cal un­cer­tainty in the UK, with busi­ness con­fi­dence down and the prime min­is­ter on his way out. What’s more, there are early signs of con­ta­gion to the rest of Europe. Pop­ulist par­ties in a num­ber of other EU coun­tries are al­ready call­ing for ref­er­en­dums of their own.

Given this, it is not sur­pris­ing that the price of gold has per­formed strongly since the ref­er­en­dum, re­flect­ing both its tra­di­tional role as a global safe haven and the fur­ther scaling back of ex­pec­ta­tions forUS in­ter­est rates. What’s more, the price of gold has risen in dol­lar terms de­spite the broad­based strength of theUS cur­rency it­self.

How­ever, we should be wary of be­com­ing car­ried away. The ini­tial panic in the wake of the UK’s shock ref­er­en­dum re­sult has faded. EvenUKe­quities have re­bounded. In part this is be­cause it has been rec­og­nized that theUKwill not be leav­ing the EUim­me­di­ately. There will be a ne­go­ti­at­ing pe­riod of at least two years, which should al­low some of the un­cer­tain­ties gov­ern­ing the UK’s re­la­tion­ship with the rest of Europe to be cleared up.

Mar­kets have also been re­as­sured by changes in the of­fi­cial rhetoric. In the run-up to the ref­er­en­dum, of­fi­cials fa­vor­ing a vote to re­main had a clear in­cen­tive to em­pha­size the risks of Brexit in order to try to in­flu­ence the out­come. But af­ter the vote, the fo­cus of pol­i­cy­mak­ers has shifted to­ward try­ing to re­as­sure busi­nesses and in­vestors. In par­tic­u­lar, cen­tral banks, led by the Bank of Eng­land, have sig­naled a will­ing­ness to cut in­ter­est rates fur­ther.

This is a mixed back­drop for gold. Safe-haven de­mand is likely to fade if the worst fears over the

im­pact of Brexit are proved wrong. How­ever, an ex­tended pe­riod of ul­tra-low in­ter­est rates would clearly be fa­vor­able. In­deed, gov­ern­ment bond yields are now neg­a­tive in much of Europe and in Ja­pan, in­creas­ing the rel­a­tive ap­peal of gold.

Look­ing ahead, the mar­kets have prob­a­bly gone too far in ex­pect­ing the Fed­eral Re­serve to leaveUS in­ter­est rates on hold for at least the next 12 months. The re­al­ity is that the global fi­nan­cial sys­tem has weath­ered the Brexit shock much bet­ter than many had an­tic­i­pated. In the mean­time, the US econ­omy is gath­er­ing pace again and do­mes­tic wage and price pres­sures are build­ing. We would not ex­pect gold to re­visit its pre­vi­ous highs of around $1,900 per ounce in 2011, un­less the wider fall­out from Brexit is so bad that the Fed is ac­tu­ally forced to loosen mone­tary pol­icy again. Nonethe­less, gold has once again demon­strated its value as a safe haven. This is im­por­tant and means that any pull-backs are likely to be tem­po­rary. In­deed, other po­ten­tial shocks lie ahead, in­clud­ing the prospect of po­lit­i­cal un­cer­tainty ahead of theUS pres­i­den­tial elec­tion in­Novem­ber. There is also a sig­nif­i­cant risk that con­ta­gion from Brexit to the rest of the Europe will prompt a resur­gence of the debt cri­sis in the euro­zone, or even spec­u­la­tion that other coun­tries will break away from the EU­too. But even if de­mand for safe havens does fade, the down­side for gold will likely be lim­ited by a re­newed fo­cus on the risks of higher in­fla­tion af­ter years of ex­cep­tion­ally low in­ter­est rates.

The au­thor is chief global econ­o­mist & head of com­modi­ties re­search, Cap­i­tal Eco­nom­ics Ltd.

WANG XIAOYING/ CHINA DAILY

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