EU economy and gold trend

EU economy and gold trend

Since the Brexit vote, the European Union has remained fragile economically with fears of possible future exits. After a successful Brexit vote countries such as Denmark, France and the Netherlands are feared that they may also initiate exit processes from the EU. This definitely puts the EU at a very uncertain situation economically, leading to many investors also shifting their wealth into commodities and trading in precious metals such as gold. The price of gold has shot up by about 45% since the year began with much of the gains in value made post Brexit due to the uncertainty in the EU economy.

First Chart

During periods of economic volatility, investors always prefer putting their money in safe havens; and commodities provide the store of wealth that the investors look for during such times. Among the most preferred commodity for value preservation when markets are in turmoil is gold. Depending on the risk appetite of the investor, they may buy gold at the earliest sign of market instability or wait until the actual volatility begins in order to run to safety. The two scenarios have played out in the gold market this year whereby, the uncertainty at the beginning of the year buoyed up gold prices; while the Brexit sparked the rise in the prices even higher.

EU financial markets affected by Brexit

Since the Brexit, the sterling pound has a lost about 10% of its value to the euro. With this currency depreciation, exports from the United Kingdom are expected to be relatively cheaper and hence boost the exporting sectors and inbound tourism to the UK. The Bank of England is however very cautious on every economic decision it is making currently in order to prevent a plunge into a recession. In its recent monetary policy statement, the BOE cut its interest rate to 0.25% in a move to encourage commercial banks to increase their lending into the economy. The expected result is that with increased money supply, demand will rise and prevent any deflationary outcome across the region as a result of the Brexit. The stability in the UK is then expected to translate to a stable EU during the transition period.

Second Chart

The BOE intervention into the UK economy through a rate cut had a positive effect on the stock market and a negative impact to the bond markets across the EU. After the Brexit vote, the FTSE 100 dropped by about 3.15% due to the referendum outcome shocks. However, after the Bank of England cut its interest rate, the FTSE 100 index went up by about 1.6%. This is an expected result since when the interest rates are lower; the bond market becomes less attractive due to lower returns. Investors that have a high risk appetite then shift their money into the stock market, which is riskier but has potential for higher returns beyond the low interest income from in the bond markets.
The long term effect if the Brexit may not be very clear at the moment. However, in the short-run we expect the gold market, stock market and commodity markets to continue gaining; as the bond markets lose and the sterling pound depreciates against other major global currencies.