US markets are plunging today on trade war talk.
US President Donald Trump signed an executive memo ordering tariffs on at least US$50 billion worth of Chinese goods. Investors fear this could be the start of a trade war.
They could be right.
According to Bloomberg, China’s ambassador to the US, Cui Tiankai, responded by saying China doesn’t want a trade war ‘but we are not afraid of it.’ If the US starts a trade war, they are ready to ‘fight to the end to defend its own legitimate interests.’
At time of writing, the Dow Jones is down by almost 3%, the S&P500 is down by 2.52%.
On Wednesday, stocks also ended the session lower after the US Federal Reserve decided to hike rates.
The Fed voted to raise interest rates by 0.25%, to between 1.5% and 1.75%. US Federal Reserve Chairman Jerome Powell said the Fed is looking at two more rate hikes this year, opposing the markets who are anticipating three.
The Fed is desperate to raise rates before the next recession hits, so they can have room to manoeuvre and lower rates to stimulate the economy.
They expect the economy to heat up with more inflation, more growth, and more employment this year.
Meanwhile, the US dollar index was down after the Fed hikes.
The US dollar index measures the US dollar against a basket of six major foreign currencies. It fell from 90.371, its highest amount since 1 March, to 89.767.
The US dollar index has been declining since the end of 2016 from a high of around 103. It has continued to decline even as the Fed has raised rates, which in theory should make the dollar stronger.
Gold price went up after the Fed’s decision
There is a popular notion that when interest rates rise, gold falls. The reasoning is that as gold doesn’t pay any yield, when interest rates rise investors move to other higher paying yield investments.
This is not necessarily true.
According to Investopedia, the correlation between interest rates and the price of gold between 1970 and 2015 has only been about 28%. That is, there is not much of a connection.
You can see what they mean in the following chart.
The blue line shows the US Fed funds, along on the left axis. The yellow line shows the gold price along the right axis.
Gold rallied in the 1970s as the US Fed raised rates to over 18%. And it did once again as the Fed raised rates between 2004 and 2006.
[Click to enlarge]
That is, higher rates do not necessarily mean lower gold prices.
Gold rallied back in December from a weaker US dollar, as you can see in the chart below.
It hit a high of around US$1,342 per ounce in spot trading.
[Click to enlarge]
The thing is, gold is also a commodity. Commodity prices have also been rising as demand from developing markets increases. A weak dollar could continue to push commodity prices up, which bodes well for gold.
Today, it is holding steady after the trade talk. At time of writing, gold is trading above US$1,328 per ounce.
But, in my opinion, gold could go higher.
Gold is used as a hedge in times of turbulence and uncertainty. And as a hedge against inflation and risk.
The global economies may be growing in sync for the first time in 10 years, but it may not last long. As the International Monetary Fund (IMF) recently warned, global growth may be starting to peak, and a trade war could certainly affect this.
Gold could rally if trade tensions between the US and China keep up.
Interest rates are also rising, in a world with ever higher amounts of debt.
Last week, the US hit US$21 trillion in debt, a record high. Only six months ago, in September 2017, it had reached US$20 trillion, according to Market Watch. That is, debt has increased by US$1 trillion in only six months.
The US deficit will only go higher after the recent US tax cuts, and as the US government spends more.
Predicting where gold will go next is not easy. Yet, as risks keep on hitting the market, central banks continue to tighten, and as debt keeps rising, gold could do quite well in the future.
Editor, Markets & Money
Ps. Crisis & Opportunity editor Greg Canavan thinks gold is about to breakout…big. But, wait. Before you go running off to buy some gold, you should read this first.