Gold prices have been trending higher all month. In fact, they’ve gained over 9% in January. But Friday was the final push to hit a new Record High Gold for the yellow metal. The noteworthy thing is that while yields are a little lower, they haven’t had as much of a dramatic move. That suggests something else is moving gold higher: Safe haven flows.
The buoyancy in gold is being attributed to the main talk in the markets this week: The potential for trade tariffs being actually implemented over the weekend. When he took office 11 days ago, US President Donald Trump said that he would apply 25% tariffs to Mexico and Canada starting on February 1st. Late Thursday he reaffirmed this commitment, which was followed by a move higher in gold. The question for traders now is whether that will continue.
Why Tariffs Are Good For Gold
The consensus in the market is that tariffs will generate inflationary pressure, as the cost of the levies are expected to be passed through to consumers. On the one hand, that higher inflation would likely keep yields up as the Fed is expected to keep rates higher to prevent inflation rising even more. But the market already is expecting higher rates, and the impact is seen as relatively small compared to the effect of higher inflation.
Gold’s attractiveness is as a store of value to offset inflation. Investors will hold gold if they think dollars will lose value. They can be tempted out of gold to buy bonds if that implies an attractive yield above the inflation rate. The expectation of higher inflation, therefore, has an effect similar to lower interest rates. So, even if yields remain steady, gold can gain if markets price in a lower real yield as a result of higher consumer prices.
So, It’s a Done Deal?
Whether the gains in Record High Gold can be sustained, however, will depend whether markets keep thinking that inflation will be higher in the coming months or even years. And that depends on how the tariffs are implemented.
The thought up until recently was that Trump was using tariffs as a negotiating tactic, and that might very well be the case. If Canada and Mexico aren’t willing to offer the concessions he’s demanding to avoid tariffs, then the tariffs have to be put in place. Otherwise, they lose their negotiating power. Trump has implied that the issue with Canada and Mexico is shipping of fentanyl across the border, and it’s unclear what would satisfy the White House in terms of tackling that problem.
The Market Reaction
Even in the hours before the deadline, there have been reports of staffers working to avoid implementation of the tariffs. One of the main issues is whether the tariffs will be applied to Canadian oil, which supplies 8% of the crude used by the US on average. A 25% tariff on Canadian crude imports would imply around a 2% price pressure on US fuel, something that would be presumably politically costly for a President that campaigned on lowering the cost of fuel.
Markets will likely be focused on the inflation implications when it comes to the tariffs, particularly with regards to gold. If the tariffs apply to materials that represent a small amount of the cost of final products (like aluminum and steel) the inflation impact could be minimal. That could hurt gold’s chances of gaining. But higher costs of energy can have a knock-on effect through supply chains, keeping inflation persistently high (such as the problem Europe is facing). That could keep gold bid for a while.