Brexit: Britain Enters Brave New World

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Summary

Britain has voted to exit from the EU 52% to 48%.

The pound sterling fell back sharply in initial reaction but has quickly recovered much of the lost ground.

A knee-jerk reaction took gold up the $1,350 level, but it then fell back to levels already seen a couple of weeks ago confounding many precious metals pundits.

The people have spoken and Britain, overall, has voted in Thursday's referendum, to leave the EU, albeit fairly narrowly. The knee-jerk reactions have set in, but interestingly the markets have already recovered substantially (at the time of writing - around 10am) and the fallout is not as bad as many had feared - so far. Obviously the markets consider that the dire warnings of the Bremain camp over the likely fate of the UK economy, and that of Europe, have been somewhat over-exaggerated. Headlines suggest the fall in pound sterling as being substantial, and it was initially, but not nearly so much as many pundits had predicted. Indeed, if one looks at recent dollar:sterling parities. The initial fall was around 12% from what had been the pound's highest level in months as these same pundits were predicting a Remain vote. Sterling has, however, already recovered much of its lost ground and if one compares levels to the average parity prevailing over the past few months, it could be said to have only fallen around 4%, a much more manageable figure than the 15-20% predicted by George Soros.

Conversely, gold, that other bellwether of the global economy, initially shot up around $100, again from a level it had come down to in pre-referendum trading in anticipation of a Remain vote, but has since come back down around $40 to a level it had reached anyway only a few short weeks ago.

So the opinion polls, and the conspiracy theorists who thought a Brexit vote would somehow not be allowed to happen, got it wrong again. We had warned here, several times, that the polls could be under-estimating the underlying groundswell of anti-EU feeling among a large sector of the UK populace and it looks as though the older we were the more likely we were to vote for Brexit. These are the generations which had experienced life outside the EU and hadn't found it to be so economically disastrous as the Bremain politicians had been warning. In short they didn't believe the doom and gloom scenario being presented, not that the Brexit campaigners were offering any more credible future. Campaigning on both sides was almost certainly misleading to the extreme, but in modern-day political campaigning the real facts are swept under the carpet and both sides tend to hugely exaggerate their own political and economic scenarios.

So what happens next? It will take 2 years at the very least for the UK to unwind from the EU and during that time the country will remain part of the Union, although one which will effectively have no say in future policies. Prime Minister David Cameron has said he will stand down and wants a replacement to be elected by the ruling Conservative party before its annual conference in October. There will be much political jockeying for positions in a new Cabinet and undoubtedly the opposition parties will call for a general election, although given they were virtually all (apart from one UKIP and eight Democratic Unionist MPs from Northern Ireland) pro-Bremain, they may find it difficult to generate sufficient votes to unseat the current government, although it could be a very close vote should it come about. However the principal opposition Labour Party has not come out well from the referendum campaign choosing to keep a much lower profile and this may work against it in the end.

If initial movements in the markets are anything to go by, the immediate economic consequences may not be nearly as severe as anticipated. The pound appears to be regaining lost ground and gold has been slipping back. The European stock indices are seeing something of a recovery from the levels to which they fell too. The reaction of U.S. markets will be interesting though, but given most U.S. citizens probably don't understand all the implications of the Brexit result, just as the Brits don't really understand the U.S. presidential election process, the effects may be muted there too.

But, longer term we do see market disruptions and an uncertain geopolitical fallout, particularly with respect to other EU states. The Dutch, the French, the Italians and the Finns, and even the Germans, are somewhat concerned about the surrender of sovereignty to the greater EU and the effects of mass immigration - the two principal factors which swayed UK voters to vote to leave. The EU will probably have to make some substantial reforms to avoid some other nations following the UK example, leading potentially to the total break-up of the economic union. This could cause member countries to make things difficult for the UK in terms of negotiating satisfactory exit agreements over the next two years lest they be seen to be offering the UK a better deal, which could affect political fallout in other EU nations which might be looking to the kinds of reforms which the UK had been seeking, but had, in reality, failed to achieve.

For the UK itself there are going to be some hugely difficult times for whoever leads the government into the Brexit negotiations. It will likely be a slow and uncertain process which will see some gains and some disappointments. Much has been made of the percentage of British exports which go into the EU which some see as at risk, although the realities of world trade may mean that this is not the case given that imports from the EU into the UK are even higher in value terms. EU exporters are unlikely to wish to see these threatened by intransigence over UK import deals.

But this is but a small segment of what will need to be renegotiated and such renegotiations take time. Some will be in the interests of all parties and may be quickly resolved. Others not so. Uncertainties will keep markets volatile and we do suspect perhaps more pressure on sterling and the UK stock market as exit negotiations blow hot and cold. Gold has not really been reacting as expected, but this could change. Some very fraught times lie ahead.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.