Sunshine Profits

About the Author Sunshine Profits

Sunshine Profits is built around the belief that we are in a secular bull market in all commodities and that precious metals will be among its greatest beneficiaries. Having established long term trends, our investment strategy focuses on evaluating low-risk entry points, as well as timing potential tops.

SPDR Gold Trust (ETF) (GLD): Gold, Brexit and Central Banks

The Brexit vote is a challenge for central banks. What does it mean for the gold market?

This week, we have already written about the repercussions of the British referendum for bond yields and European commercial banks. Today, we focus on its consequences for central banking.

Brexit may be a new phase in the global central bank experiment. As a reminder, before the referendum, the Bank of England (BoE) had been talking about hiking interest rates for months. Some analysts even argued that the U.K. might beat the U.S. to raise rates first. Now, all this talking about normalization looks like a swan song. Mark Carney, the governor of the Bank of England, said on Tuesday that the BoE was scaling back capital rules for banks in the hope of spurring more lending. And earlier, one week after the vote, he signaled that the BoE is ready to adopt a more expansionary stance to prevent a recession. He said that the BoE “can be expected to take whatever action is needed to promote monetary and financial stability, and as a consequence, support the real economy”, and suggested also that interest cuts are coming:

“In my view, and I am not prejudging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer”.

Other major central banks also face serious challenges. The Bank of Japan sees the upward pressure on its currency (due to the flight to safety), weak inflation and some market stress. Haruhiko Kuroda, the governor of the bank, has already supplied $1.475 billion in dollar liquidity to Japanese banks after the Brexit vote. It was the first such move since 2014, which signals some funding stress.

Further easing is possible also from the European Central Bank (ECB). The economic growth in the Eurozone is fragile and Governor Mario Draghi expects that the Britons’ decision would reduce economic growth by a cumulative 0.3-0.5 percent over three years. According to the June ECB minutes, the Brexit vote could generate “significant, although difficult to anticipate, negative spillovers to the euro area via a number of channels, including trade and the financial markets”. The slower pace of growth combined with elevated volatility and problems with Italian banks may put pressure on Draghi to undertake some decisive actions.

The Fed is also in a difficult situation. It wanted (at least officially) to raise interest rates, but the recent U.S. dollar appreciation and increased volatility could prevent the U.S. central bank from the continuation of the normalization process. The Fed’s “wait and see” approach and the flatter expected path of the federal funds rate should be positive for gold.

The bottom line is that the Brexit vote is a challenge for central banks. To support markets, they could abandon the normalization process and even adopt new unconventional measures, which would only add new threats to the current uncertainties. Another problem is the lack of confidence in the central bank’s fight with the consequences of Brexit. The key is that Brexit is not only an economic problem; it is also, or even mainly, a political issue. Investors may reasonably doubt whether the central bank can cope with the political crisis. Therefore, the consequences of Brexit for global central banking are positive for the shiny metal. Investors should always remember that the price of gold is affected not only by market or political events, like the Brexit vote, but also by central banks’ reactions to them.




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