by Christopher Aaron
A week ago, the British pound fell to fresh 31-year lows versus the US dollar, crashing through the lows seen after the Brexit vote on June 24. The pound sterling (GBP) fell from 1.27 down to 1.19 versus the US dollar in a little over two minutes – a true flash crash – before recovering to close near 1.24 by the end of the week. These types of percentage movements in major world currency cross-pairs would typically be expected to take several months to develop. What we are witnessing now is unprecedented volatility around the world.
The cause of the crash is uncertain. Some are blaming computer algorithms, others are blaming human panic. But the general consensus is that the crash is still related to the after effects of the Brexit vote.
From our perspective, it looks as though a mass of technical stop-losses were triggered all at once as the pound fell toward 1.27. Such can be seen from the 6-month GBP/USD chart below.
Note that after breaking support below 1.27, the pound fell over 7 points almost immediately, which was exactly the amplitude of the post-Brexit consolidation. The fact that the crash was equal to the consolidation amplitude is no coincidence, as an equal number of buyers in the 7-point consolidation range must have entered stop loss orders which were triggered sequentially below this key figure.
Further, as is typically the case, the fulfillment of one pattern leads to the manifestation of a subsequent related pattern, and the flash crash in the pound makes even more sense when we view GBP/USD action in the post-Bretton Woods era. Below is the GBP/USD chart from 1969 – present:
What becomes apparent is that the reason the UK pound flash crash occurred last week at this juncture is because it represents the completion of a massive 24-year Head & Shoulders topping pattern. Dating back from the low of 1.40 from 1993, each segment of the pattern has taken roughly 8 years to complete. Each subsequent 8-year low has seen a declining neckline (shown in black above) tested, up through the latest low post-Brexit at 1.32.
The 1.28 – 1.35 range for the pound shown on the first chart from June through October represented the last consolidation for the pound before the plunge through the neckline confirmed this pattern.
As the amplitude of the head measured 0.76, the ultimate target for this pattern is an equal distance below the neckline, which gives us reason to believe the pound will be breaking below parity with the US dollar over the next eight years and could reach a final target of 0.59. In other words, it may ultimately take only $0.59 US cents to buy one British pound.
This would represent the lowest value of the pound relative to the dollar in history. From a post-Bretton Woods high of 2.60 in 1972 to our target of 0.59, the pound will have lost 77% versus the US dollar in less than two generations.
British citizens are cautioned to consider holding only savings in the pound currency that are necessary for intermediate-term expenses, those planned within a 12-month timeframe. We should be looking at a volatile but significant further decline in the pound’s value over the next 8 years, which will cause prices of food, energy, and other basic necessities to rise when priced in the British currency.
British Stock Market Serving As Outlet For Depreciating Currency
It is not coincidental that the British FTSE 100 stock index is approaching all-time highs above 7,000 at exactly the same time the currency is hitting generational lows.
The clear phenomenon at work is the stock market acting as an outlet for the falling pound. Indeed, some British multinational companies who derive profits from natural resources or economies outside the UK may see their profits rise as expressed in GBP, so it is not surprising to see the index rise to reflect this. Below is the FTSE 100 from 1990 through the recent pound crash. Note the new nominal highs being made above 7,000:
Yet we should not confuse crashing-currency-induced rising stock markets with true prosperity. History shows that the increases in stock prices during a currency depreciation generally do not compensate for the higher prices seen in basic expenses, cost of living, and gold prices.
Gold In British Pounds Update
The British pound’s rapid deterioration against the dollar is likely an indication of further economic trouble for the UK to come. And as central banks are so prone to do, we can safely assume that the Bank of England’s response to the crisis is going to be to print more money to try to paper over the problem.
However, the impact of such actions is going to cause a further deterioration in the value of the pound. This is the forecast the 24-year Head & Shoulders pattern for GBP/USD is foreshadowing.
Of course, we must keep in mind that today the US dollar is no stable store of value either, as it itself has already lost 75% of its value relative to gold during the last 45 years.
Gold is rising in all currencies, just at different rates. At present, the world is more focused on problems with the British pound, and so pound-priced gold has remained strong, closing above 1,000 GBP last week.
Note that it was the break above the long-term declining trendline (turquoise color) in early 2016 that warned of British pound problems to come. The gold market “knew” that the pound was heading for trouble well before voters or currency traders knew the outcome of the Brexit vote. Let us keep this theme in mind over the coming year as we study gold priced in other currencies.
Closing last week above 1,000 GBP per ounce, British-priced gold remains strong and is consolidating its post-Brexit gains, despite weakness in US dollar gold. British-pound gold is now only 20% below its previous all-time high from 2011 at 1,200 GBP.
Watching For The Breakout To Come In US Dollar Gold
The reason we are paying attention to the potential for a break of the US dollar long-term downtrend for gold is because — similar to what happened with the British gold chart — the breaking of this important trendline will likely come 6-12 months before a major event occurs to draw public attention to the problems inherent with the US dollar. And as the dollar is the world’s reserve currency, the ramifications for gold prices will be much more significant.
Currently the long-term downtrend in question comes in near $1,350, as shown below (magenta color). Viewing the similar trendline in US dollar gold as was recently broken in GBP gold:
Noting how once British pound gold exceeded its declining trendline in early 2016, it had no trouble surging higher toward the midpoint of the 2011-2013 range, it would not surprise us to see US dollar gold move to an equivalent level on its chart during its next advance, which would take it to roughly $1,600 an ounce before an intermediate pause.
Final Thoughts On British Pound / US Dollar
We wonder how many average citizens in Britain have taken any protective measure for their savings whatsoever. Our contacts in Britain report knowing few friends or family members who are taking any of their savings and converting it into gold at this juncture. While reports of some wealthy investors converting portions of assets into gold immediately after the Brexit vote were heard, the general consensus seems to be that few average Britons have awareness of the need to protect themselves.
The same scenario is found on this side of the Atlantic. In our everyday conversations, we continue to observe that only a tiny fraction of those who have 401(k) retirement plans or savings in bank accounts have any holdings in gold whatsoever.
One has to wonder: if not already, then when will more citizens decide to own some precious metals?
The problems with the fiat currency system are real and we are seeing warning signs of cracks in real-time. Our long-term thesis has to do with a larger mainstream recognition that no one currency is intrinsically better than any other, leaving gold as the last resort.
Finally, here is the same chart as above of the London FTSE 100 Index, but this time with the stock index priced in gold. The nominal all-time highs currently being made are seen to be exactly that, i.e. expressed in a severely depreciating currency. When priced in gold, the British stock market is nowhere near the all-time highs set in 1999-2000: