The British referendum on the United Kingdom’s membership in the European Union is coming. Will Brexit bring financial apocalypse or deliverance from nefarious Eurocrats? What does all this mean for the gold market?
Odds of Brexit Diminish
One week ago, weabout the potential consequences of the UK’s exit from the EU for the gold market. However, we did not manage to fully cover this topic, therefore we decided to return to this issue. Last week, the odds of Brexit dropped. The Economist’s Brexit Tracker shows that 40 percent voters are in favor of a divorce, the same number as last time. However, the percentage of supporters of remaining in the EU increased from 41 percent to 47 percent. It means that the formerly undecided decided to endorse staying within the EU (we wrote that “the undecided Britons are likely to determine the outcome”).
The decreased chances of Brexit are bad news for the gold market. Indeed, the price of gold in British pounds was rising due to uncertainty over Brexit in January and February, but stabilized later. Actually, gold prices in pound sterling have been declining since mid-May.
Chart 1: The price of gold in British pounds over the last 12 months.
Brexit: Apocalypse or Deliverance?
There are divergent opinions about a Brexit’s impact on the global economy and the gold market. Some analysts argue that a Brexit is likely to push the UK into recession, while others claim that the country could grow faster without the burden of the EU’s excessive regulations. The problem is further complicated by the fact that the EU is both a political project with a centralistic and statist flavor, and the Single Market guaranteeing the free movement of goods, capital, services and people between the EU’s 28 member states.
Economic Costs of Brexit
However, economists agree that Brexit would entail big economic costs for the UK. First, the exit from the Single Market would reduce trade, immigration and foreign investment. The London School of Economics’ Centre for Economic Performance calculates that only reduced trade would cost in the long-run of 6.3 to 9.5 percent of GDP. Moreover, a Brexit-induced fall in foreign investment could cause a 3.4 percent decline in GDP, and the reduced immigration could also snatch its piece.
Second, Brexit would lead to prolonged uncertainty and, thus, decreased investment. The exit process could take a few years. And nobody knows how a new economic relationship between the UK and the EU would look like. Would the UK adopt a Norwegian model and join the European Economic Area? Would the UK choose a Swiss way and negotiate bilateral deals with the EU? Or would the UK just go alone without any ties to the EU?
For comparison, the UK’s net contribution to the EU budget amounts only to about 0.35 percent of GDP. Yes, the UK could scrap some of the EU most absurd regulations. However, it would bring limited benefits, as Britain is already among the. And the whole idea of a referendum, along with regaining independence, is to limit immigration. Therefore, Brexit could add some regulations instead of removing them. Anyway, leaving the EU would make Britain (but also the EU) worse off, according to economists. This is bad news for Britons, but good for gold, as the shiny metal usually shines during periods of political turmoil or economic distress.
Brexit and Gold
Gold is likely to benefit from safe-haven bids in the event of a Brexit vote. This is because the Britain’s exit from the EU would generate prolonged uncertainty about the new economic relations between the UK and the continent. Actually, there may be some hedging ahead of the referendum. The positive impact of Brexit on the price of gold would be strengthened if it fueled instability in the overall world market, including the U.S. market. In case of a result in favor of staying with the EU, the price of gold may decline due to the reversal of some safe-haven demands and reallocations towards more risky assets.
Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.
Sunshine Profits‘ and Editor