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The world is still shocked by the human tragedy in the Middle East. Nevertheless, the market expects the conflict to be contained, with limited financial consequences. An oil crisis seems very unlikely to unfold. We recommend staying invested.
It seems as if the series of geopolitics and shock waves is never ending.
Following the Russian invasion of Ukraine, financial and energy markets returned to normality relatively quickly. It might be this experience that explains the complacency of markets regarding the current tragedy in the Middle East.
Oil crisis fears haunt the market
The tragic Israel-Gaza war has been dominating the news headlines since the beginning of October.
Geopolitics is once again haunting financial markets. The focus has moved to oil, which is the link that would turn this regional military conflict into a global economic challenge. Fears about an escalation and supply disruptions pushed oil prices back above $90 a barrel.
The standard playbook is very unemotional. Geopolitics tends to be a noise element without lasting fundamental implications, a shock that injects a temporary uncertainty premium into prices.
With the situation still in a state of flux, we believe that scenario of a “temporary shock” as the most likely scenario that could evolve. It looks as follows:
The military conflict remains centred around Israel, within the known divides. Relations between Israel and Palestine are reset, but the impact within the region is minor, besides the heated rhetoric. The noise and uncertainty disappear, and the oil price increase reverts within days and weeks.
The precedents for this standard geopolitical playbook of a temporary shock are the Lebanon war and the previous wars in Gaza, acknowledging that today’s conflict is more intense. So far, the US and other Arab states engaged primarily in diplomacy, which seems to support this scenario.
That things evolve into an oil crisis seems very unlikely. In this scenario, the military conflict spreads further in the region, that is, Iran and others become directly involved, and political actions and attacks disrupt trade and oil flows. Oil prices rise above $150 a barrel, inflation returns, and the economy falters.
Geopolitics would become a massive exogenous shock that resets the economy and financial markets by mid-2024.
Given the geopolitical noise, oil markets seem somewhat detached from fundamentals and we see prices heading lower into next year, eventually dropping into the higher side of $70. Storage is sufficient globally and the supply-demand gap is set to close going forward.
Gold and silver shift their focus already
The conflict caused flows into safe-haven assets such as gold, government bonds and the US dollar initially.
Gold prices surged by more than 5 per cent in the days after the attacks. Such a short-term surge mirrors past moves around geopolitical shocks, mainly reflecting a shift of financial markets from risk-on to risk-off and related position-squaring by short-term speculative traders rather than any genuine safe-haven demand. Most of these safe haven flows have already dissipated.
In the meantime, the story about rising yields and inflation returned in strength and regained some of the market’s attention.
A pickup in safe-haven demand depends on how the situation unfolds from here.
However, outside of the two oil crises in the late 1970s and early 1980s, gold and silver do not have a particularly strong track record as geopolitical hedges.
While we cannot rule out an escalation of the conflict, we have a very high conviction in the established economic trends: No recession in the US, higher-for-longer interest rates and no systemic banking stress.
These trends should result in a further fading of safe-haven demand, which is why we see no need to change our views. We see lower gold prices longer term.
The overall outlook remains reassuring.
The US economy continues to surprise with resilience. The earnings season is in full swing and should offer confidence in the underlying economic strength. China is coping with structural challenges in the property market but has successfully stabilised its economy so far.
Geopolitics noise and elevated yields are distracting but we recommend staying invested.
Norbert Rucker is head of Economics and Next Generation Research at Julius Baer