Brexit: Markets in Shock, Gold Breaks Through $1,300/oz

June 27 2016

While I was expecting that the ‘Remain’-vote would reach a majority in the British EU-referendum, the British surprised the world by, with a million votes difference, opting for a Brexit. The British will leave the European Union in a trajectory that, they expect, will take over two years of negotiations. They will have to go through this tedious process, however, without British Prime Minister David Cameron. He threw in the towel after it became clear that a majority wants out of the European Union. The news shocked financial markets: gold rose over 4% (in dollars), the EUR/USD lost almost 2%, and bank stocks were hit hard. Yet the biggest danger still lies ahead.

The Biggest Danger Lies Ahead

The direct consequences are visible to each and every one. Investors are erring on the side of caution. Especially banks have had some rough days after it became clear that the British voted in favor of Brexit. The Dutch bank ING ended up almost 20% in the red and the recently privatized bank ABN Amro lost almost 15%. The Spanish IBEX suffered a large setback as well, mostly because Spanish banks have an intimate relation with the British island and banks have a large weighing in the index.

The reason why bank shares were hit hard is understandable: the nature of their activities. Many banks serve the European market from their offices in London, something that will most likely become harder with a Brexit.

A case in point is that the European Union has been threatening banks that it would no longer allow them to “clear” euros in London. That means banks are forced to move a large share of their workforce to somewhere inside the European Union. Also there are doubts about the labor contracts of European employees living in London. A relatively large share of all bank employees in London are from other European countries.

To a lesser extent companies got hit that rely on Great-Britain for a great part of their bottom line, such as Arcelor-Mittal.

The traditional safe havens, as we discussed last week, profited: the yen, the dollar, US Treasuries and last but not least gold.

But these are the visible consequences. Consequences that everyone could see or read. The nonvisible, indirect consequences might even be bigger.

The Disintegration of Europe

As soon as it became clear that the “Leave”-vote would take home the victory, congratulations started pouring in from all over Europe. Dutch politician Geert Wilders was one of the first in congratulating the British for their “Brexit,” while it did not take long for French Marine le Pen to follow in his footsteps.

However, it did not end with just congratulations. Geert Wilders, for instance, promised voters to organize a referendum for a NExit, if he is to be elected Prime Minister. Marine le Pen did the same: she also pleads for a French EU-referendum. She might use a Frexit-referendum as a campaign promise.

Fortunately for the Eurocrats, the socialist-leaning Spanish party Podemos (which means: We Can) did not take advantage of the momentum of the successful Brexit-vote. One of the campaign promises of Podemos was to withdraw from the EU and the euro. It seems that Spanish voters were shocked by the initial reactions of financial markets on Brexit. For now, they choose stability over revolution: Podemos disappointed by ending as the fourth biggest party, while in the polls it was ranking second.

Yet this is not the end of a “Spexit”-vote.

This was already the second time the Spanish had to cast their votes. There is political deadlock in Spain. After the first elections, none of the parties could reach an agreement to form a government. It was the first time in Spanish history that its king, Juan Carlos I of Spain, had to call for a second round of elections. However, nothing has changed. With the outcome of Sunday’s elections, the Spanish need a miracle to break out of their political deadlock and form a viable coalition. In short, the Spanish might even need a third round of elections in a matter of months, if it turns out that forming a majority government is an impossibility with the results of this Sunday.

One of Podemos’ campaign promises was to leave the euro and the European Union. For now, a “Spexit” seems far away, but Brexit will, especially as financial markets recover from Thursday, inspire other nations to follow in Great Britain’s footsteps.

A Brexit will lead to similar initiatives in Spain, Greece, France, and the Netherlands (in the most recent polls, the “Freedom Party” of Geert Wilders polls first with a significant lead against the other parties).

Meanwhile the Eurocrats will do everything within their power to nip the Brexit-momentum in the butt. Government leaders will be blackmailed to not allow under any condition a referendum on staying in the European Union, much less a binding referendum.

It is revealing that the chairman of the European Commission Jean-Claude Juncker seems to be in blind panic for the past few months. Juncker already declared that he would do anything within his powers, including economic (!) sanctions against European Union-members, to make sure no anti-immigration party will ever rise to power in Europe.

My pessimism on the future of the European Union after the Brexit-vote was quickly followed by investor George Soros, who said Brexit “makes EU's dissolution 'practically irreversible'”. One of the long term, not directly visible consequences, is the complete disintegration of the European Union.

And this is, in the long run, one of the most bullish factors for higher gold prices. The gold price could rise far above its last record high when Brexit is indeed a first step toward a complete disintegration of Europe.

Europe Is Mad, the Rest of the World (and Putin) Relieved?

The Eurocrats are furious. How could the British not see that Europe brought London so much wealth and riches?

The rest of the world, however, heaves a sigh of relief. Finally, the British can sign trade agreements with other countries in the world without the interference of Brussels.

But one of the problems, and so far this has been a repeating tactic of the European Union, is that Eurocrats turn trade into a game of “him or me.”

A case in point is the Russian market. The Russian economy could potentially profit from a Brexit, because the British are no longer forced to participate in the EU’s trade sanctions against the Russians. With David Cameron resigning (he was a strong proponent of trade sanctions against Russia) and the British leaving the European Union, there is nothing that stops Great-Britain from signing bilateral (free) trade agreements with Russia and other countries. One of the possible successors of David Cameron is, by the way, London-mayor Boris Johnson, who actually has Russian family roots.

Yet there is still a risk that the European Union (E.U.) one way or another forces through its will. In the past, the E.U. has threatened with higher trade tariffs and restrictions when a country wanted to trade with both E.U. countries and countries that the E.U. does not approve of. In this way, non-E.U.-countries are forced to comply with the will of the E.U. A non-E.U.-country is de facto a E.U.-country, because it complies with European legislation while not being allowed to trade with other countries outside the European trade bloc.

That is the real risk with carrying out a Brexit. How will the European Union behave and will she try to “punish” the British in an attempt to prevent similar initiatives from arising in other E.U.-countries? Such “punishments” might turn into an ugly conflict, especially when the successor of David Cameron is willing to sign free trade agreements with countries that are not “friends” of the E.U.

Brexit Has Two Underlying Motives: One of Them Is Frightening

The above assumes that Great-Britain wants to open itself up for the world. And a part of the Brexit-movement arose from this desire.

Yet that does not tell the entire story.

The flipside is rather frightening. There is a part that voted in favor of a Brexit as well, but certainly not to open up for the world. This is a group of national-socialists, which will turn to increasing protectionism and trade barriers to “protect” domestic interests.

And that can only end in one way: bad.

If Brexit not only leads to a disintegration of the European Union, but also to a disintegration of inter-European trade, then the future of our continent is black as soot.

Initial Reaction to Brexit Is Frantic, But Short-lived? Great Uncertainty about the Future

Perhaps the initial reaction of financial markets to Brexit is frantic, but only short-lived. What is more important is that Brexit might be the first step toward a disintegration of the European Union.

Even just for this reason owning gold for the coming years is a must.

And we have not even discussed the (possible) reaction of Mario Draghi and Janet Yellen to Brexit. Both said they “would stand ready” when the “Leave”-vote would gain a majority in the Brexit-referendum. For them, that means only one thing (in fact the only thing they are capable of): more monetary stimulus. Instead of rate hikes, the market now even factors in a rate cut in the United States. The coming month will prove whether this expectation has any justification.

In case both central bankers turn words into action, gold prices might reach that $1,400/oz rather soon.

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