Britain's Investors are becoming fearful of the pound sterling's demise after it fell to its lowest rate against the US Dollar. The slide comes notwithstanding the Bank of England’s regular base interest rate hikes throughout 2022, bringing Britain’s base lending rate to 2.25%.
Although gold prices have reached 2.5-year lows against the US Dollar, gold has been a sanctuary for British investors, with the desire to buy gold intensifying with premiums on gold sovereigns increasing despite higher gold prices. Investors are willing to pay more to secure physical in recent weeks as they seek to insulate themselves from the relentless pound-selling on foreign exchanges.
Gold reached a record high against sterling on Mar. 8, 2022, reaching £1,580/oz as Russia invaded Ukraine. Could the poor sentiment for sterling lead to a fresh record high for the gold price?
Background
The pound sterling is the oldest currency that is still in existence. It was once the world's reserve currency and, to this day, is one of the G10 currencies. Its performance on foreign exchanges has been dire this decade due to political and economic woes.
The UK government’s response to the pandemic was a massive stimulus package despite record borrowing leading up to the announcement of the budget. Further, the UK has recently placed a price cap on wholesale power, effectively putting the UK taxpayer in a short position on the wholesale energy market.
Again, a policy that suggests more borrowing and liabilities funded by seigniorage could lead to further devaluation of sterling.
UK Balance Of Payments
The UK government has markedly increased its spending as a percentage of GDP since the great financial recession of 2008.
The unfunded liabilities that have led to this increase have not been unwound since then, which shows how the UK has lost competitiveness on the global stage.
The UK has become a bubble economy that relies on the government’s deficit spending, which is funded by debt and seigniorage. This has been a major factor in the sterling’s demise.
The graph below shows how the UK’s debt situation has deteriorated. The market has not been too harsh in devaluing sterling until now because central banks are raising their base lending rates which, in turn, is increasing the cost of servicing government debt.
Source: UK Office of National Statistics
Compounding The Issue
The UK government announced an emergency budget in September 2022, unveiling a series of tax cuts. The market immediately dumped the sterling because the tax cuts were not met with reductions in government spending.
Effectively, the UK government has cut its income and left expenditure unchanged, which will only cause further loss of confidence in the pound.
Technical View - Gold
The chart plots gold measured in pounds and shows how a technical resistance trendline has been breached with a convincing close near the session's highs.
This predicts further upside for gold, given that no significant resistance is observed between the current market and previous record highs. Therefore, the path of least resistance is now a rally for gold against the pound.
Fundamental View
Current consumer price inflation stands at 9.9%. With leading UK high street banks paying savers 0.5% interest per annum on balances on deposit, holders of cash are losing over 9% in real terms on their savings.
Even if savers could receive interest equivalent to the Bank of England’s 2.25% base rate, their return will be -6.75% when adjusted for inflation. With this, it stands to good reason that shrewd investors buy gold bars and coins so that the negative real return of cash cannot confiscate their wealth.
This factor supports the technical findings outlined above because a negative real return will rapidly erode savers' purchasing power. In contrast, history shows that gold bullion typically rises to offset the loss of purchasing power in any given currency.
Strategies
British investors should consider diversifying their cash on bank deposits and buying liquid gold assets such as gold sovereign coins. International investors could benefit from the poor fundamentals of sterling by selling the pound currency pairs. Positive momentum continues for the US Dollar, so a good position to take against the pound is to long the US Dollar against sterling.
There are risks to positioning against the sterling, however. The pound is already relatively depressed against the US Dollar, so a rebound is not out of the question, and so investors should wait for a rally in the pound before entering any short positions.
The one caveat in the fundamental picture for the pound is if the government announces a large cut in their spending with a view of reducing their borrowing. The market would likely perceive this to be positive for the UK economy’s future, and the pound could rally.
Given the myopic view of recent governments, there is unlikely to be any appetite for the current government to announce spending cuts given that the Conservative party is now lagging Labour in current opinion polls. Therefore, any strong rally in the pound is unlikely, raising the chances of gold making new highs against the sterling.