How long Brexit uncertainty reigns is key for commodities and gold

Union flags are attached between buildings along Oxford street in central London. (AFP)

LAUNCESTON, Australia: Amid the horror for many, the elation for others and the shock for virtually everybody of the British vote to exit the European Union, perhaps the most measured and predictable response was from commodity markets.
As it became clear on Friday that the Leave camp was going to pull off an unexpected victory, commodities did what they normally do in a period of heightened risk, they declined.
The outlier of course was gold, which also did exactly what it was expected to do by rallying strongly as investors sought the protection of what is still viewed by many as the ultimate safe-haven in times of crisis and uncertainty.
The gain in spot gold was a strong 4.6 percent from the close on Thursday to the close on Friday, reflecting the scale of the shock of the British vote, commonly referred to as Brexit.
Brent crude oil declined 4.9 percent from Thursday to Friday, meaning its drop was of a similar magnitude to the rise in gold.
While it’s sometimes difficult for people to take a stand-back view of a tumultuous event, it’s probably the case that while the moves in gold and crude oil were certainly large, they were by no means signs of a panicked market.
For example, Brent had a bigger one-day percentage drop as recently as Feb. 9 this year, when it slumped 7.8 percent amid investor concern over a supply glut in global markets.
Gold’s rally on Friday was less than half the almost 11 percent jump from Sept. 17, 2008, when investors flooded into the yellow metal at the height of the equity rout during the global financial crisis.
These examples in no way seek to minimize the impact of the Brexit vote on commodity markets, rather they aim to provide context that while the price action is significant, it wasn’t exceptional or without precedent.
Other major commodities were more restrained than crude oil and gold, with London benchmark copper futures dropping 1.7 percent on June 24 and London aluminum slipping by 1.5 percent.
In Asia, Shanghai steel rebar fell by only 0.23 percent, while spot iron ore was down 0.6 percent.

HOW QUICKLY CAN NORMALITY RETURN?

What becomes key for commodity markets now is how long the Brexit crisis drags on for, or put another way, how long before markets are reassured that all the negative news is out there and priced into expectations for global economic growth.
While it’s easy to be caught up in every twist and turn of what is sure to go down in history as one of Britain’s most turbulent political periods, the trick is probably to ignore the media hype and concentrate on the bigger picture.
Markets dislike uncertainty and it does seem that Britain has set itself up for at least several months in this state, as the ruling Conservative Party jostles to find a replacement for outgoing Prime Minister David Cameron and the opposition Labour Party appears set for a leadership challenge as well.
Beyond the immediate weeks of political uncertainty there exists the broader issues of how Britain can negotiate to leave the EU on terms acceptable to both, how London’s financial industry can adapt to life outside the EU, how big a hit to growth will Britain take, and what effect this will have on the global economy.
There is also likely to be further political fallout in the form of a potential second Scottish independence referendum, calls for Irish reunification and the emboldening of far-right parties in the rest of the EU.
None of this bodes particularly well for commodities normally aligned with economic growth, such as crude oil and the major industrial metals.
It does argue for gold to maintain a bid tone for as long as uncertainty remains the prevailing sentiment.
While the political shenanigans inside Britain are captivating to watch (and probably of vital interest for those who have to live with the consequences), of more importance to global commodity markets is how quickly everyone can be convinced that the fallout from Brexit can be successfully contained, or whether it is a contagion that infects more than just a seemingly bewildered Britain.

— Clyde Russell is a Reuters market analyst. The views expressed are his own.