Trade Wars and Commodities

“Trade wars are good and easy to win”

Trump triumphantly tweeted back in March of this year after initially imposing tariffs on solar panels and washing machines.

Since that initial ‘easing in’ the US has imposed a 25% tax on steel and a 10% tax on aluminium imports. A further 25% tariff on $50 billion worth of Chinese goods (most coming into play on July 6^th), and various other similar tariffs or threats on what you would normally deem traditional US partners.

North, South, East & West – Friend or Foe

To the North; Canada was the hardest hit in terms of Steel tariffs, with the country being the biggest supplier of Steel and Aluminium to the US, exporting nearly 90% of it’s steel to the country.

The country fired back, promising to impose dollar-for-dollar tariffs on the US on products including orange juice and other food products as well as steel.

To the South; Mexico has also suffered from Steel levies that continue to damage and question the future of the Nafta trade agreement, retaliating by slapping tariffs on US bourbon and pork amongst other things.

To the East; the Europe stood together against US moves with the block imposing 25% tariffs on a range of $3.2bn worth of US products…to which Trump reacted by saying they will be placing a 20% tariff on all cars coming into the US.

Trump Tweet: “if [EU trade tariffs] are not soon broken down and removed, we will be placing a 20% Tariff on all of their cars coming into the U.S. Build them here!” 

In reply, Jyrki Katainen, the EU commissioner in charge of jobs and growth, told the French newspaper Le Monde that if Trump applies new tariffs to European cars, as he threatened this week, the bloc “again, would have no choice but to react.”

To the West (or far east if you like); US imposed 25% tariffs on $50bn worth of Chinese goods (most come into play on 6^th July). China escalated the issue by threatening an additional 25% tariff on USD$34bn worth of US goods, including energy and agricultural products…targeting Trump supporters in the Midwest.

Tariffs on Global Growth

The global establishment has been relatively united in condemning US moves, questioning Trumps apparent obsession with closing the trade surplus America has with different nations across the globe.

The US is the largest economy in the World. It is also a highly developed nation with over 2/3rds of its GDP derived from personal consumption. One may think that, with that in mind, the chances are they may import more than they export. Not Trump, apparently.

World Bank on protectionism: “Disrupt worldwide supply chains and affect long-term productivity”

IMF: Trade Wars “not only hurt global growth, they are also unwinnable”

S&P Global’s chief economist, Paul Gruenwald, earlier in the month on CNBC’s Squawk Box stated that global GDP growth could take a hit to the order of 1% if tariff threats turn into a trade war.

The Reality is, however, that global growth is still pretty robust, expanding 3.7% in 2017, a projected 3.8% in 2018 and 3.9% in 2019, according to the OECD (Organisation of Economic Cooperation & Development).

We would argue that in terms of effect on global growth, tariffs may end up being a bit of a bluff (other than for some specific markets) and that central bank moves may, in fact, be the one to watch over the medium term.

The Fed’s recent insinuation that it may hike rates four times, not three, over 2018 with increasingly hawkish rhetoric combined with the recent announcement from the ECB that it will terminate QE in December mean that the end of ultra-low interest rates and a return to more established monetary policies (See Arion article: ‘Goodbye QE, Hello QT – Feb 2018).

It’s also worth noting that what Trump initially says, is not always what necessarily happens. His technique of hitting hard early and then negotiating from a position of power is well documented. 

Tariffs on Commodities

If an all-out trade war descends and global GDP slows as a result it is it is a reasonable assumption that growth related commodities (Energy/Base Metals) could suffer long-tem, whilst Gold could profit as a safe haven.

Interestingly, Gold has yet to move and is actually trading around its lowest level in 6 months - an indication of the strength of the greenback. Whether Trump allows the US$ strength to continue to be this strong is another question, as it complicates his need to reduce US trade deficit.

The US dollar has in fact risen more than 7% since the US administration’s decision to impose tariffs on imports. Not a positive signal for commodities, that are priced in the currency.

What we have witnessed, is an increase in volatility.

Since March this year Zinc has hit 10-month lows, Copper is sitting on recent lows and BCOM (Bloomberg commodity) Index has seen its year-to-date gains erode over the last month. At the same time Nickel is up 20 odd percent and Aluminium has experienced swings of over 35% thanks to Tumps sanctions on Russian oligarchs.

As long as the US and China, two of the biggest producers and consumers of commodities, trade tit for tat on the tariff front, commodity markets will continue to look vulnerable. With that vulnerability, comes increased volatility. 

Arion’s take on current environment and increased volatility

Commentary from Darius Tabatabai, Portfolio Manager.

The environment remains exposed to risk with talks around a ‘trade war’ just the latest in a line of politically driven headlines. Since March these have included:

•           US Russian sanctions flip-flopping
•           US-North Korea Talks
•           Italian Election Risk
•           OPEC risk
•           Iranian Sanctions (US again – I am beginning to think Mr Trump has a PA account trading vol…)
•           And now…TRADE WAR!

This has not necessarily resulted in an overall higher volatility environment but the increasing sharpness of moves on headlines are indicative of a system more exposed to risk. We remain alert to signs of surrender in the real economy, as a potential sign of capitulation in the system.

For now, we are selective about our trades avoiding an outright long volatility position, preferring to structure our trades via skew positions that capitalise on low levels of vol and skew in our markets.

For the non-specialists: things have the potential to get scary and at such times we feel like insurance on fear is usually underpriced. We will look to buy some when we think the time is warranted. With levels this low, our risk reward is high, and we look to this as a medium-long term trading bias so long as the broader environmental factors persist. Trade war headlines are the latest concern, but we don’t doubt that more risk is probably on the horizon!

Author; James Purdie, Head of Investor Relations

Disclaimer: Although this document has been issued by Arion Investment Management, it is important to note that the views of the author(s) may or may not represent that of the company. The document has been derived from sources believed to be current and accurate as at the date of release. The comments made are general in nature and do not take into account anyone’s personal needs, financial situation or requirements and past performance is not an indicator of future returns. Before acting upon anything associated with this document we would recommend seeking advice from your financial advisor.

This document is a 'Marketing Communication' as defined in Directive 2014/65/EU of the European Parliament and the Council ("MiFID II") and Commission Delegated Directive (EU) 2017/593 ("MiFID Org Regulation"). This publication is not intended as investment research. This publication has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and is not subject to any regulatory prohibition on dealing ahead of the dissemination of investment research. Arion Investment Management does not make any representations as to the monetary value of this publication. For further information, please contact: info@arioninvestmentmanagement.com.

About the company; Arion Investment Management Limited is a commodity focused investment management company, based in London. The company is authorised and regulated by the Financial Conduct Authority (registered no. 742037). Registered with the U.S. Commodity Futures Trading Commission (CFTC) as a Commodity Pool Operator and member of the National Futures Association (NFA).