Here’s What the Brexit Vote Will Do to the Value of Commodities

Britain's departure from the European Union will affect different commodities in different ways.
By Kim Iskyan ,

Some commodities have had an excellent run lately, but that may be coming to an end. And the reason is Brexit.

When voters in the U.K. decided to leave the European Union, markets immediately felt the effects. The British pound dropped 8% in a day, hitting a 30-year low. Commodities were hit, too. The S&P GSCI (a benchmark commodity index) fell 3% the day after the vote. And oil was especially hurt by Brexit, losing 4% that day.

Most markets have since recovered, including broader commodity indices. Overall, commodities enjoyed a second-quarter growth spurt with their best three months since 2010. And the S&P GSCI was up more than 12%, which brought its year-to-date return up to 10% (as of June 30). But since then, the GSCI has lost ground and is now up 5% for the year.

Other commodities, like gold, shined brightly. Gold experienced its biggest daily increase since 2013, surging 4.7% once the voting results came in. Silver and platinum also grew, with prices rising 3% and 2%, respectively.

(More on gold, and the whys and hows of buying it, are found in a free 22-page report you can download here.)

But due in part to Brexit, some commodities may struggle for the rest of the year.

Brexit's Impact on Commodities

Brexit could cause an economic slowdown in Europe, which could dampen economic growth all over the world. S&P Global Ratings forecasted that Brexit will cause European GDP to grow by 0.8 percentage points less than what they had initially forecast. And Japanese broker Nomura lowered its expectations for Asian GDP growth (excluding Japan) by 0.3 percentage points, to 5.6%.

How and when Britain leaves the European Union will have a big bearing on how much economic growth slows -- or even whether a slowdown happens at all. The longer the process takes, the longer the uncertainty in the U.K. and Europe will last. And a longer period of uncertainty means delayed investment decisions across Europe, affecting economic growth throughout the region.

Where do commodities fit in? If Brexit uncertainty leads to slowing European (and Asian) economies, it will mean less demand for commodities. And less demand means lower prices.

The Dollar's Effect on Commodities

That's only part of it, though. Adding to the drag on commodities from the Brexit fallout (and maybe even more importantly) is a stronger dollar.

With greater uncertainty over the future of the EU, some investors may prefer to park their cash in what's perceived as the lower-risk American market, and U.S. Treasury bonds. This desire for "safer" assets is reflected in what happened in the Treasury market immediately after Brexit: U.S. government bonds experienced their biggest two-day price increase since 2011.

The value of the dollar increases as demand for U.S. Treasury bonds increases, since buying U.S. bonds entails first buying dollars. And greater demand for the U.S. currency causes it to increase in value.

The effects of this new demand can be seen in the chart below. The U.S. dollar index, which tracks the value of the dollar against a basket of other currencies, reached its highest level since March. The index rose 2% the day after the Brexit vote, and is now up 4% since May.

Every major commodity is priced in dollars, so changes in the value of the greenback have an impact on commodity prices. Commodities such as oil and copper become more expensive for international buyers if the dollar is strong. But high prices hurt demand, and demand eventually falls as a result, and this causes prices to fall. Then the whole cycle starts all over again.

The commodities that will be affected the most are industrial metals, such as aluminum, copper and zinc. This is because they closely follow movements in the U.S. currency. So, if the dollar keeps going up, these metals will feel it.

If the Britain/EU divorce goes smoothly, uncertainty over Brexit -- and the jump in the dollar -- could disappear. Negotiations will include the status of financial institutions, trading relationships and many other issues. If it all gets done quickly and amicably, investor confidence will rise again and the uncertainty in Europe will fade. Then, Brexit would only have a small negative effect on European economies.

If that happens, commodity prices will strengthen. And as investment dollars return to Europe from the U.S., the dollar will weaken and commodity demand would increase.

Precious Metals Will Rise Regardless

In the meantime, precious metals are a better option. Commodities such as gold and platinum are also "safe havens" for investors, and their prices climbed when other markets were falling after the Brexit vote.

Brexit has definitely created an atmosphere of uncertainty in Europe. During times like these, precious metals like gold are investors' way of insuring themselves against uncertainty. This uncertainty pushes the price of gold, silver and platinum higher, which is something every investor wants to be a part of.

And don't forget to download our special report about why now is the time for you to own gold, along with three great ways to do it. Click here to get your copy.

Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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