The decision of the British people to leave the European Union in the face
of extreme fear-mongering shook the markets initially, but they turned up at
quarter end. The vote does not end the uncertainty, of course: the
negotiations on Britain's exit, increased agitation against membership in
other countries, the change of political leadership in Britain, as well as
the potential break-up of the United Kingdom, all add uncertainty to an
already turbulent global environment, and markets do not like uncertainty.
Brexit also provides yet another reason-excuse-for the Federal Reserve and
other central banks to keep interest rates excessively low for longer.
Brexit disaster scenario overdone
No doubt, the decision by British voters to leave the European Union opens up
some uncertainties about the future, some of which will be around for some
time. But much of the fear-mongering ahead of the vote was nonsense on
stilts. Judging by the frenetic reaction of the political elite and the
markets, you would think Armageddon was upon us.
Their reaction no doubt was aggravated by their clear inability to get the
outcome right, to imagine that anyone-other than ill-educated, anti-immigrant
hoi polloi-could possibly even think of leaving their club. Based on the
reactions, you would think the British had voted to return to their caves,
not simply to leave a bureaucratic, statist, closed-shop (closed, that is,
except when it comes to North African "refugees").
The economic consequences for Britain need not be so bad, even in the near
term, though a punitive attitude in Europe, particularly among the French,
the Dutch and the Brussels bureaucracy will make a sensible withdrawal more
problematic. And why would Europe not be hostile? After all, Peter Tusk, the
chairman of the uber-bureaucratic European Council, thinks Brexit means
"the beginning of the destruction of Western political civilization in
its entirety." Only somewhat more temperately, the Dutch Prime Minister
said that Britain had "collapsed monetarily, constitutionally,
economically." Britain has existed for hundreds of years, long before it
joined the European Economic Community (emphasis mine) with a currency
and constitution lasting rather longer than those of France, or Germany, or
Italy. . .or Holland, for that matter. Others predicted Brexit would lead to
the inevitability of World War III.
Of course, if you really believed any of this you would be in panic mode
right now. Methinks the "remainers" and Europeans rather over-egged
the pudding. The reaction of the British bond market-typically, a cautious
barometer of the economic outlook-would suggest it will not be so dire. It's
also worth noting that the British stock market was up over 10% in the week
after the vote.
It's worse for Europe
The truth is that the EU needs Britain-the world's fifth largest economy, and
one of the largest net-contributors to the EU's bloated budget-more than
Britain needs Europe. Britain is the third-largest importer of German
products, for example, importing twice as much as it exports to that country.
Britain is the EU's largest single export market, again importing far more
than it exports. Does Europe need to keep their doors open to British trade?
You bet your brie and gorgonzola they do. And if the EU plays tough? There
are always the U.S., Switzerland and China, Britain's second, third and
fourth largest trading partners.
Britain regaining its sovereignty is in fact a tremendous economic
opportunity for Britain in the medium and longer term. The outlook for Europe
is less certain, particularly if anti-federal parties in France, Italy,
Holland and elsewhere demand their own referenda. If the European bureaucracy
plays hard-ball with Britain, that would provoke more anti-EU sentiment in
Europe. But if it makes it too easy for Britain, then some others might ask
why they are staying. In the long-run, a break-up of the European Union would
be a positive thing, freeing Spain, Italy and, most of all, Greece from the
German straightjacket, while also allowing the northern countries to pursue
the more rational monetary policies they would prefer. Britain, in voting to
leave, has started the process of the disintegration of the EU, and, whatever
the longer-term outlook, that will raise unpredictable issues in the near and
medium term, keeping markets on edge.
Gold resumes rally on Brexit
One thing we can bet on, however: Brexit provides yet another excuse for the
hesitant Federal Reserve not to raise interest rates. Ongoing low rates plus
uncertainly over Europe are positive for gold, which has been, and will
continue to be, the major market beneficiary of the Brexit vote, though
clearly the rally was well advanced anyway.
Low rates and Europe are not the only reasons to be positive on gold.
Production is now clearly seen to have peaked and is heading down. As the
U.S. presidential election draws near, markets will begin to focus more on
the impact of the new president; policies of either Trump or Clinton would
likely result in a lower dollar, though at the risk of more protectionism. A lower
dollar would be positive for gold prices.
Though many well-known hedge fund managers have plunged dramatically into
gold and gold stocks, and inflows into the ETFs continue to be strong-so far
this year, about 60% higher inflows than the net outflows for all of 2014 and
2015 combined-many investors large and small remain on the sidelines. They
think they have missed the move or are waiting for a correction. This is a
reason to think that any correction in the near term is likely to be shallow
and short-lived.
Gold stocks still undervalued
The gold stocks remain undervalued on a historical basis, though not as cheap
as earlier in the year. Price-to-book value of the Philadelphia Gold and
Silver Index (XAU) of leading gold and silver miners, for example, at 1.8
times is double the multiple of the end-of-the-year lows, but that's below
the levels from 2000 until 2012, where p/bv's were more often around 3 times.
The higher gold prices of the past quarter will see the miners' valuation
multiples drop meaningfully, I suspect, once quarterly results are reported.
So for the main part we will be holding the gold stocks that dominate our
list of holdings. We are also holding U.S. and global equities in the broad
market, though more selective and cautious in buying.
#1 Gold Fund
The Europac Gold Fund, managed
by my advisory firm Adrian Day Asset Management, ended the first half as the top-performing
precious metals fund this year.
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