It starts innocently. You just try to protect domestic industry and make your nation great again. So you impose a little tariff, just to create a level playing field with other countries. But before you know it, these other countries target your exports with retaliatory tariffs and you are in the middle of trade wars.
What are they? Trade wars are economic conflicts in which countries impose import restrictions on each other in order to harm each other’s trade. They result from protectionism, i.e. the policy which restrains international trade with the intent of protecting local businesses and jobs from foreign competition. The problem is that in the long-run trade wars entail only loses and no winners.
Why? Well, as people have different skills, free trade is beneficial for both parties. It pays countries to trade because they have comparative advantages in producing distinct goods. Instead of producing all stuff independently, it’s better for each country to specialize in the industries where it has a comparative advantage and to trade their output then. It’s much more effective (and tasty) when the French focus on preparing wine and exchange it later with the Germans for beer.
Or you can consider foreign trade as a kind of a technology which transforms one good into another. Just think what happens when the U.S. exports bourbon to Japan and imports cars. It’s basically a way to turn bourbon into automobiles! But trade restrictions make such transactions more costly, which hit the consumers.
Gold and Trade Wars
What is the link between trade wars and gold? In theory, trade wars should be positive for the gold prices. This is because they hamper the economic growth – and the precious metals shine the most during slowdowns or recessions. Have you heard about the Smoot-Hawley Tariff Act? It was signed into law in 1930 and raised tariffs on over 20,000 imported goods to record levels. Although the bill didn’t cause the Great Depression, it didn’t help the U.S. economy recover, only prolonging the suffering.
Moreover, trade wars should decrease the risk appetite, supporting the safe-haven assets such as gold. The reason is that trade wars could escalate to full conflict between states, as it was with the First Opium War. The rising protectionism in the 1930s maybe did not cause the WWII, but it definitely contributed to its outbreak. Remember: when goods don’t cross borders, soldiers will.
However, history doesn’t provide a clear guide. You see, the price of gold was freed not earlier than at the beginning of the 1970s – and since then, global trade has basically become more and more free. Surely, several trade conflicts occurred: in the 1980s, Reagan raised tariffs on European pasta and on Japanese vehicles and electronics; in 1993, Europe imposed tariffs on import of Latin American bananas; in 2002, George W. Bush lifted tariffs on imported steel; Obama also put tariffs on steel, as well as on solar panels and tires. But they were limited in scope and time – for example, after just over a year, Bush rescinded the tariffs due to international backlash and negative economic consequences.
So, let’s focus on the recent trade disputes under Trump. They started in January 2018, when the US imposed a tariff on solar panels and residential washers imports. In March, President ordered tariffs on steel (25%) and aluminum (10%). The next rounds of tariffs happened during summer (July, August and September). Ultimately, his administration slapped a 25% tariff on over 800 Chinese products, and China quickly responded with retaliatory tariffs.
How did gold react? As one can see in the chart below, this year was not positive for the yellow metal. Its price declined from slightly above $1,300 in January to $1,200 in October.
Chart 1: Gold prices (London P.M. Fix) from January to October 2018.
Interestingly, the greatest declines occurred between April and September, where trade wars were the most intense. It suggests that, contrary to theory, trade wars have actually been negative for the gold market, as they strengthen the US dollar, the main competitor of the yellow metal.
Silver and Trade Wars
Similarly, silver was not boosted by Trump’s trade wars. As the chart below shows, the metal declined from about $17 to about $14-14.5. Despite all the fuzz and panic in the media, silver was under downward pressure in 2018, which confirms our thesis that economics trumps geopolitical factors in the precious metals market.
Chart 2: Silver prices (London Fix, in $) from January to October 2018.
Gold Miners and Trade Wars
And what about gold stocks? The same story here. They performed poorly in 2018, despite trade wars, as one can see in the chart below, which displays the XAU Index. It suggests that macroeconomic factors are much more important for the precious metals that trade disputes. However, let’s note that 2018 was a harsh year for the US stock market, so mining stocks suffered as well.
Chart 3: XAU Index from January 2018 to October 2018.
Anyhow, as trade disputes have been limited and often temporary since the 1970s, data available for analysis is rather scant. However, if Trump’s actions are any guide, we must say that trade wars affect the precious metals market negatively. It may be due to their upward pressure on the US dollar, or just because other factors are more important.