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11 January 2017

The Trump Effect - and Black Swans



What’s going to affect the commodity markets in 2017? Well, the glib answer is world events and then their impact upon the supply and demand (real and perceived) of those commodities. That should cover what will move prices and dictate what sort of a year traders will have. So that would make 2017 just like any other year, which is of course a fair comment, since the change of year has absolutely nothing to do with the cycle of economic development. But if we look in a bit more depth, perhaps we can isolate a few themes that are a bit more specific and thus useful to heed. 

Cyclicality

Looking at the cycle first, I think it is reasonable to suggest that, ceteris paribus, the likelihood is that prices should continue the gentle upward trajectory of recent months, so potentially concerning events will be those that either stop that gentle improvement or cause it to become significantly sharper. So things to look at would be, for example, the risk of disruption to copper production caused by the Chilean elections later in the year; if there is protest followed by strike action at mines or ports, that would create risks in the copper supply chain, with the concomitant risk of a price spike. And, of course, as ever, the progress of the Chinese economy, which this year seems less clear than it may sometimes have been in the past.

The Trump Effect

Most interesting at the moment, though, is trying to second guess what will be the outcome of the Trump effect. We know he is going to ‘make America great again’ and ‘bring home American jobs’, but we don’t know whether the measures he will take to achieve these goals will actually succeed or backfire horrendously.

So, in no particular order, here are some of the potential questions that his election raises.  

Free Trade

First, there are the linked issues of the wall along the Mexican border and the tearing up of the NAFTA treaty. Now, in some ways that could be quite simple; build a wall, stop people crossing it and charge stratospheric import tariffs on goods that come across either that border or the one to the north. Mmm. That would probably push Americans to buy domestically-produced goods, rather than imported ones, and the hope would be that it would also encourage local employment. Sadly, though, I don’t think it is that simple. 

Let’s consider a couple of examples. General Motors produce cars in Mexico for shipment to the US. They are under threat that if the policy were followed, those cars would bear a heavy tariff to encourage them to produce in the US, thus protecting jobs. But it’s not that straightforward; because of the free trade links between the two countries, when GM invested in Mexico, at the same time US steel mills did the same, building plants down there to supply the same corporate customers they do in Detroit. So the collateral damage of shuttering plants because they are priced out of the market goes far wider than the auto companies - the whole raw material and component parts of the industry have to be considered as well. I guess the new President will have less concern for non-US companies, but BMW gives another example. I am told that the biggest plant in their global portfolio is the one in South Carolina, which produces X cars for world. They are manufactured there, then shipped to Germany for final finish and quality control (possibly a hint of something there, or I am imagining it?) and global distribution. At the same time, other models for consumption in the US are produced in Mexico (and, I believe, Brazil). Now, BMW have made it clear they will keep the Mexican plant running, which suggests they are sceptical of the planned moves and intend to stick with their global approach. One last example, from the agriculture business. The biggest tomato grower in North America is in Mexico (I believe a US-owned company, or at least with substantial US investment); their product is almost all shipped to the US, for distribution through supermarkets. They could - given the similar climate available in South Western USA - grow their fruit in the US. Except that the labour cost for that business in Mexico is one tenth of what it would be in the US…. 

I know I have simplified things a bit there, but the central point is that if the US tries to follow through with these policies to interrupt free trade, then the potential fall-out will impact directly on the commodities business, which has grown to rely on free trade. Incidentally, Mr Trump (and other protectionists) might do well to reflect on Adam Smith’s comment: “All commerce betwixt two nations must of necessity be beneficial to both.” In other words, when you seek to unbalance arrangements, be careful what you wish for.

Geopolitics

Then there’s the Iran question; will the nuclear deal be ripped up? And if so, what will be the effect on oil prices, which of course have a direct impact upon metals. And what about the threat to US-China trade? Will the US impose tariffs to reduce its trade deficit with that country, and if so, then what will be the repercussions, bearing in mind the amount of US debt now owned by China?

So on reflection, I suspect the Trump effect will actually create the major uncertainties of the year, frankly dwarfing Brexit concerns. But for sure, geopolitics threatens far more than our normal supply/demand considerations this time around.

Black Swans

Oh, and all these issues I’ve raised are unknown in terms of outcome. They are not, however, black swan events; they are foreseeable, whether they happen in the end or nor, rather than things which with our present knowledge we consider impossible, such as - pre-discovery - the black swan. I do wish people - including some large bank analysts - would stop using the phrase incorrectly, because that simply devalues it as a concept. (See “Want a Black Swan for your Lake?”, published here on 20th July 2016 for an full explanation.) 

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