by Nitesh Shah, Director Research at ETF Securities.
There were large swings in cyclical asset prices yesterday as investors track developments in a potential trade war. Towards the end of the day, investors appeared assuaged that the US and China can avoid an impasse. Should a trade war escalate we believe that defensive assets are likely to gain traction at the cost of cyclicals.
The Trump administration is playing a dangerous game. Imposing a punitive tariff on Chinese imports raises the cost of manufacturing in the US, as the price of inputs into the manufacturing process increases. Moreover, setting off a tit-for-tat trade war will be particularly harmful to both the Chinese and US economies (and by extension the rest of the world). When we first reported on the US tariffs, the Chinese retaliation was very limited, but we noted that it did not preclude further action. Yesterday, after the US provided details of which products it will place tariffs on, China provided a reciprocal response: a 25% tariff on 106 US goods targeting roughly US$50bn of imports (based on 2017 trade), matching the US’s target of US$50bn of Chinese imports into US. The list of products includes soybeans, corn and orange juice.
Affected commodities made sharp intra-day moves. From peak to trough, soybeans fell 5.5% and corn fell 4.5%. However, there were hopes that these tariffs could be avoided when the White House’s National Economic Council Director Larry Kudlow spent much of the day trying to calm markets and said they still have time work out their differences. Soybeans closed 1.95% down, while corn declined 1.93%. Hopes of a resolution led to the S&P 500 gaining 1.34% yesterday. Soy and corn are trading up at the time of writing.
We believe if this trade war escalates further, cyclical commodities including base metals could get hurt as prospects for global growth are scaled back. Global purchasing manager indices already appear to be losing steam in recent months after reaching a seven year high and the trade war could shake confidence.
In this environment of uncertainty, defensive assets like gold could benefit, playing off its long-established safe haven traits.
Of course the world’s two largest economic powers could realise at some point that nobody wins from a trade war and may seek to de-escalate the standoff. We saw signs of that late yesterday. In which case, base metals are likely to do well, given that most of them are in a supply deficit and given the dearth of capital investment in recent years, mine supply is likely to remain constrained.