Trump’s Trade War and the Gold Rally
After a great run from $1,242 per ounce on Dec. 11, 2017, to $1,365 per ounce on Jan. 25, 2018, a 10% gain in six weeks, gold has settled into an up-and-down sideways pattern in the six weeks since.
The sideways range has stayed between $1,305 and $1,356 per ounce with two rallies and two drawdowns. Gold marked time at $1,322 per ounce at the beginning of this week, close to the midpoint of this recent trading range.
For the past two months, the dollar price of gold has been more reactive than proactive. Rallies in gold occur on fear of a trade war and fear of a stock market collapse. Drawdowns in gold occur when trade war fears abate and the stock market regains its footing.
Since the trade war and stock market volatility are both here to stay, investors should expect gold to continue in this up-down pattern until a more definitive picture — for better or worse — emerges.
Trump’s tough talk on trade has been dismissed as posturing by some inside-the-Beltway globalist elites. It’s not. Trump is serious about the tariffs he has announced so far and has many more tariffs and fines waiting to be announced in the weeks ahead. As markets realize the trade war is real, stocks will draw down and gold will rally in a flight-to-quality move.
Gold prices fell 2.4%, from $1,349 per ounce to $1,317 per ounce, between Feb. 2 and Feb. 8, a stretch when the stock market fell 11% in a full-blown correction. This caught many gold investors by surprise.
If stocks are falling out of bed, shouldn’t gold rally on the fear trade and flight to quality?
Not right away. Gold typically declines in the beginning stage of a financial panic. This is not because gold is an unattractive safe haven; it is. The reason gold declines is that gold is always liquid at times when unwinding stock and bond positions may be problematic.
In distress, the old maxim applies: “You don’t sell what you want; you sell what you can.” Stock traders were getting margin calls on losing positions. These stock traders did not want to sell stocks into weakness.
Banks needed liquidity to meet customer demands. For all of these parties, selling gold outright or posting gold as collateral (putting it on the rehypothecation market) is a reliable way to raise cash without selling stocks in distressed conditions.
We saw this same pattern in the panic of 2008, which occurred in the midst of the great 12-year gold bull market of 1999–2011. The worst performing year in that run was 2008, a time when hedge funds, banks and brokers sold gold for cash to repair the damage they were suffering on mortgages and, later, stocks.
But any gold drawdown in such circumstances is decidedly temporary. Once the weak hands have disgorged gold for cash, the strong hands emerge to buy the dips and start a new rally.
That happened in 2009 when gold rallied 25% in the year after the 2008 liquidity crisis when the panic had passed. It happened again on a smaller scale beginning Feb. 8 when gold rallied 4% in nine days, from $1,308 to $1,360 per ounce, as the stock market stabilized and regained some lost ground.
That part of the gold trading pattern is clear. Gold falls in the earliest stage of financial distress before bouncing back and rallying once the weak hands have their cash and the strong hands start buying the safe-haven trade.
Since late February, another driver of the gold price has been rumors of a trade war and the opening shots of the trade war itself.
Trump refrained from imposing tariffs in 2017, his first year in office, based on the advice of his national security team, including National Security Adviser Gen. H.R. McMaster, Secretary of State Rex Tillerson and Secretary of Defense James Mattis.
The national security team urged President Trump not to start a trade war because the U.S. needed Chinese help to avoid a war in North Korea. However, China did not do all it could to apply pressure on North Korea.
Once China’s lack of cooperation on North Korea became clear, Trump saw no harm in confronting China on trade, a policy he’s advocated since the summer of 2015 during the early days of his presidential campaign.
On Jan. 22, 2018, the U.S. trade representative announced 30% tariffs on imported solar panels and 20% tariffs on washing machines. These tariffs applied to all imports but were aimed primarily at China and South Korea, which were the leading exporters of both products to the U.S.
On March 1, 2018, President Trump announced he would impose 25% tariffs on imported steel and 10% tariffs on imported aluminum. These tariffs were primarily aimed at China but were also applied globally. The steel tariffs ignited outrage from the EU, Japan, Australia, Brazil and Canada, all major exporters of steel or aluminum to the U.S.
On March 2, 2018, the EU threatened to strike back at the U.S. steel tariffs by imposing their own tariffs on a variety of U.S. exports to the EU including quintessentially American products such as Harley-Davidson motorcycles, Kentucky bourbon and blue jeans.
President Trump was unfazed by the threats and wrote, “Trade wars are good, and easy to win.” Trump said if the EU imposed tariffs on jeans and motorcycles, he would apply tariffs to European cars. The trade wars were escalating, at least rhetorically, before the first tariffs were even collected.
The Trump administration threats were not confined to tariffs. Chinese theft of U.S. intellectual property has amounted to a much larger attack on the U.S. economy than subsidized steel and solar panels.
Official estimates of the value of intellectual property stolen by China from the U.S. exceed $1 trillion. Trump’s proposed remedy for this theft involves massive monetary fines rather than tariffs. Still, the means of collecting those fines from China operate economically like a tax or tariff on Chinese goods.
China issued a pro forma denunciation of the fines and tariffs but did not announce any specific retaliatory measures in the immediate aftermath of Trump’s actions. China will retaliate for U.S. sanctions not with their own tariffs but with asymmetric financial warfare, including diversifying reserves away from U.S. Treasuries into gold and European bonds and with restrictions on U.S. direct foreign investment in China.
Both sides can continue the trade war in cyberspace with ongoing reciprocal theft of intellectual property and intrusions into critical infrastructure.
Gold and stocks wiggled with each twist in the trade war story. Stocks fell sharply when the steel and aluminum tariffs were first announced by Trump. Gold rallied from the low end of the recent trading range on a safe-haven trade.
Then by this past Monday the stock market decided the trade war fears were overblown. Inside the Beltway, conventional wisdom said that Trump would not follow through on his threats, that exemptions would be issued to Canada and Mexico and that even the tariffs on China, South Korea and Europe would be mitigated somehow. Gold pulled back a bit on this “all clear” signal from stocks.
Yet the conventional wisdom is wrong. Trump may give Canada and Mexico more time in the context of the ongoing NAFTA negotiations, but he expects results. If Trump cannot get concessions on NAFTA, the steel tariffs will apply with full force to Canada and Mexico.
There’s almost no chance that China, South Korea and Europe will receive any exemptions.
The elements of an escalating trade war are in place. Once markets come to this realization, stocks will revert to recent lows and head even lower while gold will break out above the recent $1,365 per ounce high and continue its march toward the $1,450 per ounce level, which I expect later this year.
This consolidation phase for gold will be viewed in hindsight as a great buying opportunity. If you do not already have a full allocation to physical gold and gold mining shares, the time to buy is now before the next leg of the new gold bull market begins.