Beyond Brexit — More Earthquakes on the Way

On Monday, 20 June 2016, I stood in the London Eye Ferris wheel. I was just across the Thames from the UK Houses of Parliament, standing with a film crew to record an urgent warning. I said that the Brexit vote, coming just three days later on 23 June, could produce a financial earthquake.

I recommended the exact strategies to avoid losses, while profiting from the catastrophe that was to come. These strategies included shorting sterling, buying gold, and increasing cash allocations so our readers could ‘go shopping among the ruins’.

As a result, my readers were prepared for what happened — unlike the elites and so-called ‘smart money’, who were totally unprepared.

I wish that were the end of it, but it’s not. New earthquakes are coming soon as part of the Brexit aftershocks.

By now, you’re familiar with the basic outline of the Brexit story. On 23 June, the UK public voted 52% to 48% to leave the European Union. Markets had clearly priced for a ‘Remain’ victory.

The result was an instantaneous and violent repricing.

Gold gained over US$40 per ounce, stock markets fell 4%, sterling crashed almost 10%, and the euro sank 4%, all in a single day. These are large percentage moves for a full year. To happen in one day is the financial equivalent of a 7.0 earthquake on the Richter scale.

The key question for investors is whether this is a one-time repricing of assets, or whether it’s the start of something with a long way to run. If the latter view is correct, then it’s not too late to profit from some of our favourite plays, including long positions in gold, short positions in sterling, and long positions in US treasury notes.

At Currency Wars Trader, we don’t believe that markets are efficient, or that forecasting is impossible. Quite the opposite. Our proprietary models allow us to make long-run and intermediate-run forecasts that give you time to profit ahead of the crowd.

Wall Street will tell you that you cannot foresee shocks and you cannot ‘beat the market’. Don’t believe it. While most market participants were shocked at the Brexit vote, we saw it coming a mile away using our proprietary models.

On 2 March 2016, almost four full months before the Brexit vote, I gave an interview to Bloomberg TV in which I predicted that ‘Leave’ would win, recommending that investors short sterling, buy gold, and buy US treasury notes. All of those trades have been huge winners.

Here’s an example of the proprietary models that let us get ahead of the crowd:

Source: Currency Wars Trader
[Click to open in new window]

In plain English, this formula says that, by updating our initial understanding through unbiased new information, we improve our understanding. I first learned this method while working at the CIA.

The left side of the equation is an initial estimate of the probability of an event happening. New information goes into right hand side of the equation. If it’s consistent with our estimate, it goes into the numerator (which increases the odds of our expected outcome). If it’s inconsistent, it goes into the denominator (which lowers the odds of our expected outcome). This is the method we used to correctly forecast the outcome of the Brexit vote.

Now we are using it again to forecast the aftermath of the Brexit earthquake. Our expectation is that sterling has much further to fall, perhaps to as low as US$0.80, a full 40% drop from current levels.

We also expect gold to go much higher. Gold was already heading higher for reasons unrelated to Brexit, including the Fed’s new dovish stance on interest rate hikes. But Brexit uncertainty gives added impetus to the uptrend already underway.

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What are some of the data points included in the equations behind our updated forecast?

  • Brexit is just the beginning. No sooner were the votes counted than the Scottish National Party began calls for a new referendum for Scotland to leave the UK and remain in the EU. A logical result of this would be for Scotland to adopt the euro as its currency and abandon the pound sterling. This will put more downward pressure on sterling.
  • All of the political parties in the UK are in turmoil. A fight has broken out in the Conservative Party to replace the current Prime Minister David Cameron, who announced his coming resignation after the Brexit defeat. The Labour Party is in disarray because frontbenchers who wanted to remain feel that Labour leader Jeremy Corbyn did not do enough to lead the Remain forces. Finally, the leader of the UK Independence Party, Nigel Farage, has been excluded from the Brexit negotiations with the EU. Farage vows to take revenge in Brussels, where he is a member of the European Parliament and can have a say on Brexit from the other side of the table.
  • The EU is likely to take a punitive approach to the Brexit negotiations. This will be done as ‘an example to the rest’, in order to head off other nationalist movements that want to quit the EU. By showing that there are high costs to leaving the EU, the core EU leadership — Germany, France, Italy — hopes to dissuade others from leaving.
  • With the UK out of the EU, the European Central Bank will ban the settlement and clearance of euro-denominated transactions in London. These transactions will have to be settled and cleared inside EU member nations in centres like Paris, Amsterdam and Milan. The result will be a diminution in London’s role as a financial centre beyond what even the pessimists are currently predicting.

The list goes on, but you get the point. Only a small portion of the impact of these events has been priced into markets already. This means that the market trends we identified, short sterling, long gold, etc., have a long way to run. You can read more about specific recommendations to profit from these events, and our Currency Wars Trader strategy, here.

Above all, these trends mean uncertainty. Markets have ways to price risk on a probabilistic basis, but markets have no way to price uncertainty where almost anything can happen. In these situations, markets go to the safest of safe havens. That means cash, US treasuries, and gold.

The slump in gold and gold-related stocks from 2011 to 2015 is no mystery. It had to do with the Fed’s tightening policies and strong dollar policies after the dollar hit an all-time low in August 2011.

Now that the Fed is pursuing a dovish weak-dollar policy, gold is poised to go much higher.

All the best,

Jim Rickards,
Strategist, Currency Wars Trader

Editor’s Note: This article was originally published in Money Morning.

Jim Rickards
James G. Rickards is the editor of Strategic Intelligence, the newest newsletter from Port Phillip Publishing. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.

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