Recent headlines regarding the situation in the Middle East can hardly be viewed positively. Since the US pulled out of the agreed nuclear disarmament with Iran last year, tensions have been steadily rising. Now, we have alleged Iranian attacks on oil tankers and more US firepower arriving by the day. Iran has the second largest population in the Middle East, at 83 million, is the 6th largest oil producer and holds the 2nd largest reserves of natural gas and seemingly on its way ‘once again’ threatening to become a nuclear weapon state.
Throughout history, we have seen tension in the Middle East creating oil supply concerns, pushing up prices. Often, these accompanied economic growth worries, amid rising inflation and interest rates. But, in today’s markets, no-one seems to worry about anything. Stock prices remain elevated, maybe it’s the permanent high plateau that Irving Fisher talked about in 1929! The oil price has hardly budged and inflation expectations and interest rates are falling, not rising. Que raro!
Since 2nd May, Trump’s administration has imposed a policy of zero imports of Iranian oil due to Iran’s unwillingness to consider negotiations over the JCPOA. In addition to this, Trump is looking to block import waivers from all of Iran’s major export countries such as China and India, in order to put extra pressure on Iran with the threat of a serious economic situation. As a result, sanctions could remove another 500,000 barrels per day from the market.
In response, Iran has threatened to stop the flow of oil production from other big suppliers via the Strait of Hormuz. However, the Strait of Hormuz is around 20 miles wide and would be very difficult for them to block it for a long period of time. Furthermore, Saudi Arabia and the UAE have alternative pipeline routes that could avoid the Strait of Hormuz, with Saudi able to send around 6.5 million barrels per day around the Persian Gulf.
Although these sanctions seem to present a serious problem for Iran, China said that Iran’s oil was too cheap to pass up, and it has been increasing its purchases of Iranian crude oil in 2019, up to 700,000 barrels per day in April. It is likely that China will try to bypass these sanctions which will significantly reduce the threat to Iran’s exporting revenue. How the US will react to this, is up for discussion but it certainly doesn’t help ongoing tariff and trade war talk.
The market appears to be pricing in zero % probability of anything escalating, but we believe it is just another example of declining volatility, in all asset classes and would be very wary of complacency at this time. A neutral observer could be forgiven for thinking that the current status is only one spark away from an outright outbreak of hostilities in the region. What then? While the long-term gold/oil ratio at 24 is at its average for the last decade and high compared to the noughties, any war and an oil spike could well see gold rise significantly as well.
Of course, no one cares until they do. Donald Trump and the market-place are far more focussed on the Federal Reserve’s projected path of interest rates of 2019, a complete U-turn from the 2018 with gradually rising rates. With record unemployment at 3.6% in May, wage inflation rising and bullet-proof stocks, who in their wildest economic dreams could imagine that we would need to price in three Fed interest rate cuts, back down to the zero-bound. Maybe, this is ominous in its own right, and a Middle-East war is a mere side-show.
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