Disruption and Volatility

in the Commodities Markets

After a decade of economic stimulus from the various central banks, the global economy is finally showing signs of a broad based economic recovery, according to the International Monetary Fund last year. As a result, the prices of most commodities have been slowly and steadily increasing. With increasing demand from higher economic activities, prices of base metals, oil and gas, and other commodities have improved and recovered from their previous low prices.

 

However, in 2018, the economic and foreign policies of the Trump administration may not only jeopardise the global growth, but they may also disrupt the supply chain of commodities around the world as well as affect significantly their prices. 

"Trump started a tit-for-tat trade war and he remained determined to rectify the "unfair trade practices" by imposing tariffs on all trade partners that have significant trade surpluses with the US."

Impact of trade war on Commodities

At the beginning of 2018, President Donald Trump started imposing tariffs on solar panels and washing machines from China and South Korea. Subsequently, steel and aluminium were targeted with tariffs of 25% and 10% imposed respectively. Despite the fact that Trump said that China with its massive trade surplus with the United States (US) was the main target, these steel and aluminium tariffs mainly hit the close US allies. With no room for negotiation, US allies like the European Union, Canada and Mexico eventually retaliated with their own tariffs on American products that included many types of commodities. 

Tariffs on steel and aluminum that President Donald Trump signed at the White House on 8th March 2018

As a result, Trump started a tit-for-tat trade war and he remained determined to rectify the "unfair trade practices" by imposing tariffs on all trade partners that have significant trade surpluses with the US. He also used this tactic to force the North American Free Trade Agreement (NAFTA) partners - Canada and Mexico - to renegotiate the trade deal. Besides ongoing talks, no new NAFTA deal has been made yet. But both Canada and Mexico have already imposed tariffs on a wide range of products including agricultural commodities and farm products. 

 

Focusing his attention on China last April, Trump instructed the US Trade Representative to consider imposing tariffs under Section 301 on $100 billion worth of Chinese products coming to America. He subsequently increased the amount to $150 billion just before the visit of Vice Premier Liu He, who came to Washington to negotiate and resolve the trade dispute between the two countries. China remained consistent in its approach and responded that it would retaliate by imposing tariffs on an equivalent amount of American products. 

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In the meanwhile, for the steel and aluminium tariffs, China already imposed tariffs on $3 billion worth of 128 American goods ranging from pork, meat and fruit to steel pipes. Moreover, last April, with the escalation of the war of words and the sanctions imposed on the Chinese company ZTE Corporation, China put a levy of 179% on the sorghum trade. This effectively stopped all American sorghum from coming to China. As the trade war escalates, China may focus on other agricultural commodities from America, particularly soybeans as well as oil and gas.

Trade Tariffs causing Disruption in Commodities Supply Chain

All these trade actions by the Trump administration and the tit-for-tat retaliation from the other countries are definitely going to affect the trading and movement of the basic commodities. Moreover, they will also affect the global supply chain - both upstream and downstream - of many industries, from mining, processing and shipping of these basic commodities to manufacturing and transforming them to the final consumer products.

 

With a global overcapacity of steel and aluminium, if tariffs are going to block a significant amount of these products from reaching the US, the excess production will have to be diverted or dumped into other markets. Moreover, these tariffs will eventually be paid by the final consumer; hence demand of consumer goods will be affected. As a result, while American consumers may reduce their demand of products using more expensive steel and aluminium like cars, prices of these same commodities may also collapse globally with producers, dumping them wherever possible.

Rural America predominantly voted and are continuing to strongly support Trump. Hence, to counter Trump's tariffs, all the affected countries like Canada, China, European Union and Mexico have shrewdly targeted these Trump supporters by imposing their own tariffs on agricultural commodities. These are aimed to force these supporters to put pressure on their respective Republican representatives and Trump to change these protectionist policies.  

The US is a major exporter of agricultural commodities to China and agriculture is also where the US maintains a major trade surplus. However in the ongoing trade conflict, these commodities may be targeted and the agricultural trade will significantly deteriorate. For instance, when China imposed the 179% levy on sorghum, trade was completely disrupted. Overnight, the sorghum trade to China ceased and traders had to divert their ships loaded with sorghum elsewhere or resell these cargoes at significant discounts.

In the event that the US and China do not come to an agreement on trade and escalate this trade war, the agricultural commodities will be greatly affected. If China retaliates with tariffs on American agricultural commodities, not only Chinese consumers will be facing higher prices, but China will also have to find replacement for these commodities from other countries. And indeed, these commodities from the US will not be easily replaceable.

"Overnight, the sorghum trade to China ceased and traders had to divert their ships loaded with sorghum elsewhere or resell these cargoes at significant discounts.

Hence the tariffs from the Trump administration are and will continue creating volatility within the commodities markets. And the tit-for-tat response from the US trade partners will exacerbate the situation. In addition, the global supply chain will be disrupted with traders and shippers needing to sell the US agricultural commodities to other markets as well as find alternative sources for China. 

 

Future Uncertainties on Commodities

In the short term, there will be volatility in the commodities markets due to the various trade actions taken either by Trump or the other US trade partners, including China. Demand for steel and aluminium will be affected and in turn, this will also affect the major companies mining iron ore and bauxite. Ultimately, the investment plans of miners as well as steel and aluminium producers may be affected.

 

As for agricultural commodities, American farmers caught in the trade war between the US and the world will be affected. This will not only affect the prices that they can sell their products, but it will also affect their crop cycle. With all the uncertainties, farmers will have to not only think carefully about what crop to plant, but also account for the risks in terms of the costs for replanting and the potential future selling prices. 

 

If this trade war is escalated further and prolonged over a longer term, the global economic recovery may also be affected. Despite the fact the American economy looks strong and sustainable, any slump in the global growth will also negatively affect the US. As a result, in a worst case scenario, if the world economy goes back into recession again like in 2008, demand for all commodities will drop and their prices will collapse again. 

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