- Political uncertainty beginning to impact bond and property markets
- UK bonds and stocks at all time record highs and ‘bubbly’
- FTSE looks overvalued and ripe for sharp correction
- “Air of caution in the run-up to the general election” hits London property
- City of London has most to lose from Brexit
- Brexit may isolate UK – “North Korea option” – or lead to strong, independent UK, like Hong Kong
- Real diversification remains only “free lunch”
With all the focus on Grexit in recent weeks, investors have not paid much attention to the risk posed by ‘Brexit’ or the possibility of the UK leaving the European Union.
This is the case in currency and stock markets with the FTSE and sterling remaining buoyant despite obvious risks. Indeed, gilts remain close to all time record highs – in part due to QE.
The FTSE 100’s successive new record highs in recent weeks despite the deteriorating global economic backdrop has echoes of previous bubbles. We all know how those ended – see chart below.
FTSE 100 Index – 1985 to March, 2015 – (Thomson Reuters)
That may be beginning to change as U.K. two-year government bonds posted the longest run of weekly declines in eight months today. Ten year gilt yields reached the highest level in almost three months last Friday.
The fall in gilt prices is being attributed to concerns about rising interest rates. It is likely that some of the weakness could be related to election and ‘Brexit’ risk.
Political risk has already been cited as a reason for a slowdown in the London housing market with RICS UK citing a number of “challenges” facing the London housing market including “an air of caution in the run-up to the general election”.
Cameron has promised that a referendum will be held before 2017 if he is re-elected. Pre-election jitters are showing in option prices ahead of May’s poll. This week the maturity of the three-month rolling sterling-dollar option passed the election date, and implied volatility jumped sharply according to the FT:
“Equity options are priced for a move in the FTSE 100 the day after the vote, up or down, of close to 4 per cent, up from 1.5 per cent at the start of the year, according to Kokou Agbo-Bloua at Société Générale.
Derivative traders anticipate more volatility than usual because the outcome of the election is more uncertain than usual. No party is likely to have a majority, and a coalition will probably be harder to put together than in 2010, when politicians were under intense pressure amid a weak economy and jumpy markets. Psephologists expect a minority government, risking another election not too long afterwards and adding to policy uncertainty.”
In a sign investors are expecting a close-run election, a gauge of the volatility of the sterling over the next six months rose to a two and a half year high in February.
SocGen analysts said in a report last week that an exit from the EU might trigger a 20% decline in the FTSE 100 by the end of 2017.
A report from the Open Europe Study suggests that Europe would be less inclined to negotiate favourable agreements pertaining to the financial services sector in Britain because it runs a large trade surplus with the EU.
Financial services sectors in the EU would therefore have little incentive to grant advantageous terms to their British rivals. The report also refers to the European Parliament’s alleged hostility to the UK’s financial sector as a possible motivation to restrict Britain’s access to the single market.
“Post-Brexit the centre of gravity within the EU may shift towards a tougher regulatory regime for accessing the single market. The European parliament’s hostility to Anglo-Saxon finance could prove a major stumbling block.”
The Financial Times ran an interesting piece yesterday attempting to dissect the implications of a “Brexit” as presented by both sides of the debate.
The FT concluded that it is impossible to agree with either side’s analysis as both sides assume the outcome of negotiations that have not taken place.
We would add that they ignore the instability that the very act of Britain voting to leave the EU would create, and the impact such instability would have on negotiations. This is especially the case given the very fragile state of the European Union at this time – economically and indeed politically.
Gold in Sterling – 10 Years
Advocates of a “Brexit” envisage a Britain like Hong Kong, strong but independent of Europe’s burdensome regulation and directives and somewhat imperial super state ambitions.
Those opposed to it, like Gordon Brown, have suggested it would leave Britain isolated. Brown went so far as to alarmistly describe it as the “North Korea option”. Open Europe do not regard either outcome as credible.
The uncertainty surrounding a possible “Brexit” will likely take a toll on sterling itself and sterling denominated assets such as property, equities and gilts.
Political risk now clouds the outlook for the UK and sterling assets. Investors and markets do not like uncertainty. UK investors seeking to hedge these political risks should consider an allocation to safe haven gold.
In life and in finance, there are very few “free lunches.” However, investors today continue to be able to avail of the only free lunch in finance and investing which is diversification.Having all your eggs in sterling or any other currency basket is imprudent and diversification remains key in order to protect and preserve wealth in the uncertain times of today.
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MARKET UPDATE
Today’s AM fix was USD 1,161.00, EUR 1,079.40 and GBP 770.41 per ounce.
Yesterday’s AM fix was USD 1,173.75, EUR 1,077.97 and GBP 776.86 per ounce.
Gold in Sterling – 1 Day
Gold rose 0.1% percent or $1.20 and closed at $1,166.90 an ounce yesterday, while silver slipped 0.5% or $0.08 to $15.79 an ounce.
Gold hit a three month low in Asian trading as a strong U.S. dollar and expectations of a June U.S. interest rate hike keep gold under pressure.
Technical analysts are predicting the next support level for gold at $1,150 per ounce.
Tomorrow the Greek saga may take centre stage again as delegates from the European Commission, IMF, ECB – known as the Troika, and Greece will meet to discuss economic reforms.
Dutch finance minister & ESM president, Jeroen Dijsselbloem, said, “Greece won’t get any more cash from its 240 billion-euro ($258 billion) rescue program until its official creditors are satisfied that Tsipras is committed to all the economic fixes needed to meet its conditions.”
SPDR Gold Trust, the world’s largest gold-backed exchange-traded fund, saw the bearish trend continue as holdings fell 0.43 percent to 753.04 tonnes on Monday, their lowest in more than a month.
Gold near end of day trading in Singapore was $1,161.65 per ounce. In late morning trading in London, spot gold was $1,162.08 down 0.38 percent. Silver was $15.73 or unchanged, while platinum was $1,137.40 off 0.72 percent.
Gold’s weakness in recent days is very much a function of dollar strength versus the euro and importantly gold has remained firm in euros.
