Trump’s Trade Wars Could Spark A Massive Drop In Oil

Today, I am breaking with two of my rules in writing these pieces. I generally try to steer clear of politics and to avoid being alarmist or overly sensational. What has forced me to ignore both rules is the announcement on Thursday by Donald Trump that he is going to enact tariffs on steel and aluminum next week. Politicians in general have less influence on economies than they think, but they can cause disruption, and particularly when they make economic decisions for political reasons. That is what this is, and it has the potential to cause a massive selloff of oil and other commodities.

You may feel that this is ultimately good policy and given the circumstance, a strong argument can be made that is true. Here though, the timing of the announcement suggests that it is in response to what looks like increasing chaos in the administration and a Special Counsel’s investigation that seems to be moving inexorably closer to the President himself. In other words, it is a political play, regardless of the potential short-term economic consequences. The actual results of imposing tariffs and sparking retaliation, however, are not the point. What matters, as is so often the case, is perception, and the perception of traders will be that measures such as those proposed could pose a serious threat to global growth and thus cripple demand for oil.

There has been a lot of focus during oil’s recovery back into the 60s on supply, with the output cuts from the OPEC led group of producers leading to a reduction in the worldwide glut of crude. But, those cuts are only effective if demand continues to grow. Enacting tariffs on steel and aluminum may not seem that big a deal to some, but if history is our guide there is a good chance that it sparks a trade war that has effects way beyond U.S. boundaries. Again, even if that is not the end result here, the fear of it is enough to cause disruption.

The reaction to the announcement so far, both in oil and stocks, has been somewhat muted. Both have dropped over the last two days, but in a relatively orderly fashion. Presumably that is because some people believe that pressure from the President’s economic advisors such as Gary Cohn and fellow Republicans appalled by what they see as policy that is ideologically unsound will force a change of heart. That, however, looks unlikely. Consistency has not exactly been a hallmark of Trump’s political career thus far, but the one area where it has been seen is in protectionism. It was a theme throughout his campaign and has remained one, so hoping for a reversal at this point makes no sense.

So, if we have a situation where the President, for reasons of consistency and political expediency, looks set on an action that threatens global economic growth, what should we do about it?

The obvious thing is to short oil to take advantage of a potential sustained decline. The best way for most people to do that is through a leveraged Bear ETF such as DWT designed to go up as oil goes down and leveraged by a factor of three. Products like this are not perfect, as management fees, the cost of leverage and rollover costs mean that the correlation between the price of the ETF and the price of oil is not perfect. In this case, for example, if oil drops 25% your return would be less than the 75% you might expect.

For a situation like this, though, DWT offer a few advantages. First, it can be bought and sold in a stock margin account. You may have to fill out a form to acknowledge that you are aware of and comfortable with the risk involved, but most people should have ready access to the product. Second, once the position it can be run like a stock position. There is no need to worry about rollovers as there would be with futures, and a simple GTC stop can be used for protection. In this case, with a low in DWT of $10.20, a stop at around $9.80 makes sense initially.

Until yesterday, I had a bullish opinion of oil in the short term, even though I still believed that we would see a drop back later in the year. Trump’s announcement yesterday, however, was a game-changer and I am now positioning for a sharp short-term drop.

By Martin Tiller