Will Brexit Boost Gold?

Over the weekend, David Cameron, British Prime Minister, announced a referendum to decide whether the UK should remain in the European Union. What does it mean for the gold market?

EU-UK Deal

David Cameron’s conservative party won the elections in 2015 promising to reshape Britain’s ties with Europe and announce a referendum by the end of 2017 whether the UK should stay in or leave the European Union. Surprisingly (as he is a politician), Cameron kept his promises. On Friday, the agreement between the UK and the EU was reached. The deal focuses on welfare, immigration and sovereignty. First, child benefits for the children of EU migrants living overseas will now be paid at a rate based on the cost of living in their home country. Second, the UK will be able to operate an emergency brake on migrants’ in-work benefits for seven years. Third, the EU treaties would be amended to state that references to an ever closer union "do not apply to the United Kingdom”. Fourth, the deal also introduces a “red card” system, whereby national parliaments representing 55 percent of EU population can block new EU law. The deal also introduces the rule that countries not in the euro will not be called on to fund euro bailouts and that companies and individuals cannot be discriminated on the basis of their home currency (it means that British businesses cannot be discriminated for being outside the Eurozone). Moreover, the British government will be given new powers to stop suspected terrorists and criminals coming to the UK, not only if a threat is “imminent”, there will be introduced new rules to stop people coming to the UK via “sham marriages” while the EU will increase efforts to cut bureaucracy.

Cameron announced a deal as a victory reforming the EU for the better and strengthening Britain’s special status in the EU. According to him, the agreement is strong enough to campaign for Britain to remain in the EU. On the other hand, some analysts believe that the deal offers only minor changes. We also would not call the agreement as truly revolutionary. However, what is now the most important is the referendum.

Referendum

Cameron set the referendum for June 23, 2016. Thus, few months of political wrangling and uncertainty awaits us, especially that recent referendum polls have been neck and neck. Indeed, the ink was hardly dry on the deal, when the British ruling party split into the supporters and opponents of a Brexit. On Sunday, prominent and popular London Mayor Boris Johnson said that he backed the “leave” campaign. His announcement raised the probability of a “leave” vote. In consequence, the British pound tumbled to a seven-year low, while the demand for gold in Britain surged.

Gold and Brexit

Gold, priced in pounds, rose on Monday. The chart below shows that gold (in pounds) was boosted by uncertainty over Brexit.

Chart 1: Gold price in British pounds over the last 12 months

The fears of Brexit should also support gold priced in U.S. dollars, however, to a smaller extent due to the greenback’s appreciation against the British pound. Leaving the EU could deter investment and would weaken exports and London’s position as a financial center. To be clear, we are not a big fan of the European super-state with its overgrown bureaucracy and excessive regulation, however, investors should not forget that the European Union is also a single market of 500 million people.

Conclusions

The key takeaway is that David Cameron has reached a deal with the European Union allowing him to campaign for staying in the Eurozone in a referendum set for June 23, 2016. The next four months will be full of uncertainty, which should support the price of gold. On the other hand, investors should always remember that gold is traded mainly on the Fed’s actions and the U.S. economy. The uncertainty about Grexit did not boost safe-haven for gold priced in the greenback. On Monday, gold did not jump after Johnson’s announcement. However, a Brexit would be a much more important event, as the UK is a much bigger economy than Greece while gold is under less intense pressure from the threat of the further Fed hikes.