Brexit Polls Reflect A 'Dead Heat'

by: Ivan Martchev

With a little over two months to go before the Brexit referendum on June 23, the polls in Britain are dead even. The latest Economist poll shows 39% in favor of staying in the European Union (EU), 39% in favor of leaving, and 12% undecided. In fact, polls have changed little since the referendum date was set. Other polling parties show slightly different numbers, but it is fair to say that all polls are within the margin of error of a virtual dead heat on the future of Britain's EU membership.

United Kingdom

Since the poll figures are little changed over the last six weeks, the GBPUSD exchange rate has also been little changed. This oldest of cross rates in the currency exchange world is dubbed "cable," since the data for this exchange rate was carried across the Atlantic by a large cable used for currency quotations.

The British pound was the world's reserve currency before the dollar assumed that role, and the loss of Britain's reserve currency status after World War II cost it dearly in terms of the exchange rate.

British Pound Versus United States Dollar Chart

One can see how the U.S. Civil War rubbed negatively on the U.S. dollar in the 1860s, but the U.S. economy and the dollar stabilized after that war. It has been downhill for the pound ever since the 1930s. World War II and the loss of reserve currency status was a big catalyst for further pound weakening.

British Pound Versus United States Dollar Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

From a shorter-term perspective, the pound weakened going into the Scottish referendum, compounded by the resurgence of the dollar against multiple global currency pairs with the tapering of QE. Of late there has been another leg lower upon the announcement of the Brexit referendum date.

The key question is: Will the recent low of 1.3833 hold?

I seriously doubt that the pound will hold above that level by June 23, even if the polls stay "as is." I think people may feel similarly to the Scottish referendum, where we had a dead heat going into the voting week, even a slight advantage for the independence vote, but ultimately cooler heads prevailed. I think dead-heat polling data will bring the pound below $1.30, while a rise in Brexit support polling numbers may even bring it close to $1.20. While there has been a precedent for countries leaving the UK - like Ireland - there has never been a precedent for countries leaving the EU.

I think the rebound in the commodity markets, which is led by the seasonal uptick in oil prices, is helping many commodity-oriented currencies gain ground against the U.S. dollar and in that regard pressuring the Broader Trade-Weighted Dollar Index. Pressure on the dollar from multiple fronts is helping the pound temporarily, but as the referendum approaches I think the pressure on the pound will intensify.

Commodities Research Bureau Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The rebound in commodities, as depicted by the CRB Commodity Index, can only be described as a dead-cat bounce. Granted, it has caused quite the furious short squeeze in many natural resource-producing companies, primarily in the metals and energy space. This rebound is also tradeable in nature and may have a little more room to run. But I do believe that it will be completely unwound, this fall at the latest, similar to other seasonal rebounds in the CRB Commodity Index that can be seen in 2015 and 2014.

Euro Versus United States Dollar - Monthly OHLC Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I cannot imagine that the Brexit referendum is positive for the euro, which after falling rather rapidly from $1.40 to $1.05 has spent most of the time over the past year confined in a trading range of $1.05 to $1.15. The reasons have been that the ECB has been less aggressive than hoped and the likelihood of four U.S. rate hikes in 2016, as originally expected at the time of the first rate hike in December 2015, has greatly diminished. It is possible that all four rate hikes get cancelled, but since central bankers' great egos are known for having trouble admitting being wrong, another misguided rate hike may still be in the cards.

Just like Greece leaving the euro was a negative for the common currency, the UK leaving the EU (after it already left the electronic predecessor of the euro, courtesy of George Soros' massive bet in 1992) is still a negative for EURUSD exchange rate. This is because it sets a bad precedent. If other countries follow suit, this great confederate experiment will be in danger of collapsing and so will its common currency.

More Bankruptcies like Peabody Energy Coming

The largest U.S. corporate bankruptcy of the year (so far) happened last week. The level of its debts listed in federal court was $10.1 billion. This shows what happens to over-leveraged commodity producers in a bear market for their underlying commodities. The Peabody (NYSE:BTU) bankruptcy is a derivative of the bursting of the Chinese credit bubble and its effect on the prices of energy commodities, one of which is coal.

Peabody Energy Corporation Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The price of metallurgical coal has tumbled about 75% since its 2011 peak. Peabody spent $4 billion in 2011 to acquire Australia's MacArthur Coal Ltd. (OTCPK:MMSDF) to expand its sales to the steel industry at precisely the wrong time, just as the Chinese economy was beginning to downshift. (See Bloomberg April 13, "Coal Slump Sends Mining Giant Peabody Energy into Bankruptcy.") Even though the Australian operations aren't part of the bankruptcy, the slowdown in China, which is far from over in my view, sunk Peabody. (Please note: Ivan Martchev does not currently own a position in BTU. Navellier & Associates does not currently own a position in BTU for any client portfolios.)

Market Vectors Coal Exchange Traded Funds Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

While I would admit that the rebound in many coal producers may not be over, if one looks at the Market Vectors Coal ETF (NYSEARCA:KOL), I think after the short squeeze fizzles out we are in for a retest of the low at $5.30, similar to the way we retested the low in 2008. KOL is a global ETF where the U.S. coal producers come third in the weighting, but since the situation in China transcends boundaries I expect more repercussions globally if we see a Chinese recession, as I expect to be the case. (Please note: Ivan Martchev does not currently own a position in KOL. Navellier & Associates, Inc. does not currently own a position in KOL for any client portfolios.)

KOL Country Weightings Pie Chart

There is a well-known overcapacity in the steel industry in China. China's Industry Ministry plans to reduce annual steel capacity to about 1.1 billion tons by 2020 while domestic consumption is unlikely to exceed 700 million tons. China has been dumping steel on global markets at a rate of 100 million tons annually. But this increase in steel exports is putting pressure on other global steel producers. (See Financial Times, April 10, "China says its steel overcapacity will remain.") I think that the estimates from China's Industry Ministry do not factor in a Chinese recession, which I think is likely. If that happens it is difficult to see a bottom for steel prices, iron ore, or coking coal for that matter.

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