Gold after Brexit

Brexit-Gold2

I expected an identity crisis in the UK exactly as it happened except that I expected the collapse of United Kingdom (UK) into England and Scotland to start once the UK was out of the European Union (UE). The fast reaction of Scotland to stop the Brexit process is larger and more decisive then I expected. Besides Scotland it seems also that Northern Ireland and Gibraltar are joining in. It was evident to me a Brexit would happened since UK’s Margaret Thatcher decided to confront EU’s François Mitterrand (France) and Helmut Kohl (Germany) in the 80s. The opposition to Brexit was also strong then and ex-prime minister Edward Heath threaten to put up a strong fight against any attempt. Margaret Thatcher was an excellent politician and understood that a Brexit initiative will collapse the Conservative party and split the UK and never tried even after the Falklands war when she was at her highest in the polls.

The Brexit referendum result is the worst possible outcome for the UK. It divides the country right in the middle and also puts England and Welles against Scotland. It could also restart the Northern Ireland conflict all over again. Gibraltar which is isolated and desperately needs excellent relations with Spain voted 95% to stay in the EU. Gibraltar overwhelmingly rejected proposals for Spanish sovereignty in a 1967 referendum and again in 2002. Its leaders now have indicated they might go back and do another referendum and negotiate an agreement with Spain and the EU. The situation has been made worst since most of the younger generation voted to stay in the EU and the older generation to leave. Also the weakness of the leadership of David Cameron, leader of the governing Conservative party, and Jeremy Corbyn, opposition Labour party, leaves a vacuum in UK’s leadership at the most important time in its history.

I sincerely believed, based on statements by both UK and EU leaders, that if Brexit wins, the process will last two years and that it will be cordial and smooth as it happened with the break up of Czechoslovakia into the Czech Republic and Slovakia in 1992. Both sides showed no intention to block the will of the UK people. The EU even after the referendum shows no intention to block the process on the contrary. It is now rather from inside the UK that the process might be aborted and I think it is because of such a close vote that indicates no clear conviction on the UK side. The Scottish independence movement has been growing for a long time and its desire to remain in the EU has been expressed for a long time. This was not a surprise to me and shouldn’t have been to anybody. The consequences of a collapse of UK, that would create an identity crisis for the English people, became evident to me a long time ago.

Collapse of UK would also trigger a collapse of the Commonwealth starting with Australia who has a very strong republican movement. Canada will follow but slower since the republican movement in Canada is very small compared to Australia. A smaller England is not the end of the world and could be the start of a new country as Switzerland but it also can become a Moldova if it takes the wrong direction. However, whatever the direction it takes, it will be a different country and a new identity going slowly from an empire in 1900 to a small country in 2018.

Many Brexit supporters counted on an immediate collapse of the EU and the creation of a snow ball effect in the EU, collapsing the EU into a Balkanisation that would strengthen the UK relative to its continental neighbors. However, despite anti Brussels sentiment all over the EU the low Brexit vote and the chaos created in the UK political leadership has weaken similar movements throughout the EU. On the contrary it has created more cohesion in the EU and desire of reforms in the EU. It also has created doubts in the UK even into the Brexit leadership to go it all the way with Brexit. Language by several Brexit leaders of not starting the official procedure before a free trade deal with the EU indicates a wish to push Brexit to infinity and at the same time save face for some Brexit leaders. Since before the Greek crisis I said that IF a country will leave the EU it will be the UK and not any other one, and recent events confirm my hypothesis. I also said it will collapse the UK and this is still possible if Brexit process is taken to conclusion.

For the moment the British pound is still considered a foreign exchange reserve currency and was maintained in the SDR basket. Brexit makes it a high probability for the British pound to be taken out at the next IMF SDR review in 2020. I expect, if the Brexit process is concluded, markets to push the British pound to at least parity with the euro and the US dollar (see charts in annex). Gold is not only the anti-US dollar but the anti-fiat system that includes all the other fiat currencies like the EU euro, British pound, Swiss franc, Japanese yen, Chinese yuan, Russian ruble, etc. It is not enough to look at the price of these currencies versus the dollar but versus the only hard currency and money, gold. A good but not perfect indicator for the collapse of the fiat system is IMF’s Special Drawing Rights (SDR). Created in 1969 and expressed in gold at the beginning it has become a basket of fiat currencies since 1973. It is today a basket of US dollars, EU euros, British pounds and Japanese yens. Starting October 2016 the Chinese yuan will be added. In 1980, just 10 years after the delinking of the hard SDR from gold, the new fiat SDR index lost 93% of its value in gold. As of May 2016 it lost 96%.

SDR Priced in Gold

I have been watching closely the evolution of the US dollar and the EU euro since the Greek crisis to see if all the problems in the EU will affect in a substantial way the official forex reserves holdings of euros. With all the economic and political problems, the US dollar in my opinion should have been a lot higher versus the euro and the proportion of euros in forex reserves should have diminished substantially. This is not the case. On the contrary, the last IMF data (Q1-2016) indicates a slight increase of euro reserves according to a Reuters article. This makes me speculate that China, Russia, Iran and maybe other countries are supporting the euro against the US dollar. It also indicates the weakness of the US itself. I have attracting attention since the end of 2014 of possible social and political unrest in the US and called the US a possible “black swan” in 2016, and since the beginning of 2016 it has become obvious to everybody.

The US dollar has not profited as it should have and as it did in the past from geopolitical problems and more specifically the EU crisis. It is rather the Swiss franc and the Japanese yen and especially gold that took advantage. Russia and China have substantially and regularly increased their official gold reserves since the 2008 crisis. We observed also before the Brexit vote a large increase in gold purchases by private investors in the EU and in particular the UK. If we look at the price of gold in several currencies it has increase in all of them. The price of gold in SDR has after the Brexit vote broke to the upside showing a general increase of gold price in all fiat currencies.

SDR Gold 2

SDR Gold 3

Could Brexit be the trigger of the collapse of the dollar based international monetary system and a reset? It could. For the moment massive global central bank intervention has capped forex markets and the price of gold as they promised to do before Brexit. Still, gold by breaking to the upside rather then to the downside, as some analyst predicted, indicates to me we are getting much closer to the reset than we have expected. Brexit has added not introduced a lot more uncertainty into the financial system and that is very bullish for gold. There could be a second shock of much bigger proportion in November in the US. Last week potential US president Donald Trump shocked the world with a speech on global trade. Donald Trump vows to reopen, or toss, NAFTA free trade pact with Canada and Mexico according to a recent Reuters article. He also used similar very anti EU and China rhetoric in every speech he made. This could escalate the currency wars, which have been going on since 2009, into trade wars. I expect trade wars to happened even if the Democratic presidential candidate wins but not as soon.

I didn’t expect Brexit to trigger the collapse of the EU and I still don’t. Recent events confirm rather then deny my hypothesis. However, the hysteria that was created just before the Brexit vote and reaction has escalated social tensions world wide. The next challenge to global stability will be the US election in November. More and more “Elites vs Masses” language, and not just in the US, scares the hell out of me. It sounds almost identical to “Bourgeoisie vs Proletariat” language of the 30s, 40s that ended in a world war and a communist and totalitarian movement with devastating consequences in many parts of the world. At least until the US election in November gold will try to break higher to the upside but I expect global central banks in coordination or just the US to try at least to control its upside if they can’t stop it. I believe the US wants a higher gold price but at a slow and controlled rate.

A recent statement by an ex-IMF economist, Kenneth Rogoff, encouraging developing countries to sell US treasuries and buy gold has legitimised the conversion of official forex reserves by many countries from US dollars to gold. I don’t exclude a panic buying of gold as it happened in late 60s with the collapse of the London Gold Pool. I actually expect a much larger one with the collapse of the dollar based international monetary system that will catapult gold above $2,000 towards $5,000. Uncertainty and panic are in the air and especially since the Brexit vote and that is very bullish for gold.

UK Pound Suverign

 

Annex:

1. Gold Forex Charts:

Pound Gold

Euro Gold

Gold Franc2

Gold USD

 

2. British Pound vs EU Euro and US Dollar:

Pound GBP EUR

Pound GBP USD

 

Advertisements