Brexit may 'spell the end' of high commodity prices

Brexit may spell the end for some commodities of what’s been a great few months.

The late June decision by voters in Great Britain to leave the EU immediately hurt many markets, including commodities. The British pound dropped 8 percent to a 30-year low. The S&P GSCI – a benchmark commodity index – lost 3 percent the day after the vote. Oil was also a Brexit victim and lost 4 percent that day.

Meanwhile, safe haven commodities, like gold, were standout performers. Gold climbed 4.7 percent the day of the result – its biggest one-day move since September 2013. Silver rose 3 percent. And platinum rose 2 percent.

Most markets, including broader commodities indices, have since recovered. And overall, in the second quarter commodities enjoyed their best three-month period since 2010 – the S&P GSCI was up over 12 percent. And as of June 30, the GSCI was up almost 10 percent for the year.

 REUTERS/China Daily China Daily Information Corp

But the recent strength in commodity prices may end during the second half of the year, in part because of Brexit.

Brexit’s impact on commodities

The exit of the United Kingdom from the EU could cause an economic slowdown in Europe – and hurt global economic growth along the way. Rating agency S&P Global Ratings recently said that the Brexit effect will cause European GDP to grow by 0.8 percentage points less than they had previously forecast. Japanese brokerage firm Nomura lowered its GDP growth forecast for Asia (excluding Japan) from 5.9 percent to 5.6 percent as a result of Brexit.

How bad of an economic slowdown – and whether it happens at all – depends on how and when the U.K. leaves Europe and the process involved. The longer the exit process takes, the longer the period of uncertainty for both the U.K. and Europe. This would delay investment decisions across Europe and affect economic growth throughout the region.

A slowdown in Europe’s (and Asia’s) economy due to Brexit uncertainty means less demand for commodities – resulting in lower prices.

Commodities and the U.S. dollar

Maybe a bigger drag on commodities from the post-Brexit fallout than lower economic growth is a stronger U.S. dollar.

Because of Brexit, investors now see the U.K., and European, markets as riskier investments. As a result, they are moving their money towards “safe-haven” assets like the U.S. Treasury market. After Brexit, U.S. government bonds saw their biggest two-day price rally since 2011, reflecting investors’ desire for “safer” assets.

More demand for U.S. Treasuries boosts the value of the U.S. dollar. That’s because to buy U.S. bonds, a foreign investor first has to buy U.S. dollars – and the more investors buy U.S. dollars, the more the U.S. dollar increases in value.

This new demand pushed the U.S. dollar index – which measures the U.S. dollar versus a basket of currencies – to its highest level since late-March, as shown below. The U.S. dollar index climbed 2 percent the day after the Brexit vote, and is now up 4 percent since its May lows.

REUTERS/China Daily China Daily Information Corp

This has an impact on commodity prices because every major commodity is priced in U.S. dollars. So a stronger dollar makes a barrel of oil or a tonne of copper more expensive for global (non U.S. dollar-based) buyers. A higher price could cause global buyers to cut back on their purchases, thus hurting demand, resulting in lower prices.

Of all commodities, industrial metals such as copper, aluminum and zinc follow the U.S. dollar’s movements particularly closely. So if the dollar keeps strengthening in the near term, these metals will feel it the most.

Precious metals likely to rise anyway

Uncertainty over Brexit, and strength in the U.S. dollar, could hurt commodity prices. But both of these factors could vanish if the U.K. can settle the terms of its divorce with the EU. If negotiations – over trading relationships, the status of financial institutions, and dozens of other issues – can be concluded smoothly and quickly, investor confidence in the region will return, and much of the uncertainty weighing on markets will be lifted.

This would most likely mean that Brexit would have only a small negative effect on the region’s economies. That would be good for commodity prices. And as investment flows back to a less-risky Europe (and away from the U.S.), a weaker U.S. dollar would also help to boost commodity demand.

In the meantime, precious metals are another – better – option. Precious metals (like gold and platinum) are also viewed as “safe havens.” As mentioned, their prices all climbed when markets were falling after the Brexit vote.

During times of uncertainty, precious metals like gold act as a way for investors to insure against volatility. Post-Brexit has undoubtedly created a period of market uncertainty… pushing the price of gold, silver, and platinum higher. (We have previously addressed easy, accessible ways to gain exposure to gold, silver and platinum.)

There are many other reasons to buy gold. We outline them in a free special report that you can download here.

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