Investment risk is back, with a vengeance. Iranian retaliation for the US killing of its military commander Qassem Suleimani has sent investors running for cover again, just as they were starting to regain confidence following the initial drone killing.
Geopolitical shocks like these may spook “risk assets” such as stock markets, but everything does not crash at the same time. Rising tension also fuels demand for safe havens such as gold, US bonds, the Japanese yen and Swiss franc.
When the tension is in the Middle East, the oil price also spikes, as investors rush to cash in on the surging price of crude. So as well as threats, there are opportunities.
Few expect all-out war right now, with S&P Global Ratings saying tension does not “alter our base-case assumption that any military action by either side will not lead to a fully fledged direct military confrontation”. So, what should you be buying now?
Brent crude jumped to more than $71.50 a barrel in early trading on Wednesday, after news of the Iranian missile attacks broke, before declining slightly. However, Emirates NBD said other indicators are showing little sign of stress, with the Brent/Dubai Exchange for Futures and Swaps little changed, suggesting the underlying market fundamentals are as they were.
Edward Bell, commodity analyst at Emirates NBD, says the US-Iran stand off makes for an intense start to 2020, but oil futures were already on the up, rising in eight of the past nine weeks: "Oil has been bolstered by optimism that the China-US trade war would come to an end," he said in a research note. "It is now receiving support from revived geopolitical risk.”
As we saw after last year’s drone attacks on Saudi Aramco oil processing facilities at Abqaiq and Khurais, the impact on oil prices can be short-lived unless markets foresee a serious threat to oil flows.
The big fear now is that either the US or Iran raises the stakes with fresh retaliatory measures. The oil price could head towards $100 and beyond if Iran disrupts supplies flowing out of the Gulf region or Iraq, either by blocking the Strait of Hormuz or cutting pipelines.
So should you rush to buy oil stocks? George Lagarias, chief economist at Mazars, says the US is no longer a net importer of oil, so is less sensitive to price spikes. “The market's knee-jerk reaction to Middle Eastern tensions dates back to the 1970s, when an oil embargo was largely blamed for a recession and runaway inflation.”
Today, Saudi Arabia is best served by stable oil prices, while Iranian production has already been discounted due to US sanctions, Mr Lagarias says. “Loss of Iraqi oil could put upward pressure on prices, but Saudis could balance that by turning on the taps, in exchange for continued American pressure on arch-enemy Iran.”
Outlook: As tensions ratchet upwards, the oil price will surely follow. Yet in the long term, fossil fuels will still remain under pressure amid climate change fears and the shift to renewables.
Gold has been a store of value for thousands of years and true to form, the precious metal hit a seven-year high after the Suleimani killing, climbing 1.7 per cent to $1,579.60 an ounce.
By Tuesday, it had retreated to $1,570.22, but Iran’s missile attacks have sent it to a fresh high of $1,589.90, some 21.91 per cent higher than a year ago.
Olivier Konzeoue, foreign exchange sales trader at Saxo Markets, says the gold price was already climbing throughout the Christmas holidays due to seasonal demand, even before the rush to safety. Buying in the immediate aftermath of an attack can be risky, though. "We expect gold to redeem some of its recent gains at the first signs of de-escalation,” Mr Konzeoue adds.
Ned Naylor-Leyland, manager of the Merian Gold & Silver Fund for Merian Global Investors, says silver has been climbing as well, but war talk is not the main driver.
The US Federal Reserve cut interest rates three times last year, and markets anticipate further loose monetary and fiscal policy this year, and this could do more to drive the gold and silver price higher than geopolitical risk.
Gold does not pay any interest and is therefore more attractive when the rates on rival safe havens such as bonds and cash are near zero.
Something else could make gold shine, Mr Naylor-Leyland says: “Institutional allocations are at their lowest, relative to historic levels, which means we are potentially on the cusp of an ongoing flood of liquidity.”
Gold is the “zero-risk” instrument of choice for central banks, the super-rich and the Asian public, he adds. “2020 could be the year the wider investment world returns to monetary ground zero in a major way.”
Vijay Valecha, chief investment officer at Century Financial, says gold stocks are highly undervalued relative to gold. “Gold miners have suffered a lacklustre few months and have plenty of room to mean revert higher,” he says.
Negative eurozone interest rates and further rate cuts from the Fed will help. “Exchange traded fund VanEck Vectors Gold Miners ETF (GDX) is an ideal way to ride this trend.”
Outlook: Tension or no tension, gold could shine this year as monetary policy loosens again. Gold benefits from the troubles in the Middle East.
US government bonds
US government bonds, known as US Treasuries, are another renowned safe haven, and prices rose both after the deadly drone strike and news of Iranian retaliation.
Bonds pay a fixed rate of interest so when prices rise, yields fall, and Markus Allenspach, head of fixed income research at private bank Julius Baer, says the renewed demand for safe assets cut the yield on a 10-year Treasury, from 1.94 per cent on Wednesday last week to 1.78 per cent. Demand and bond prices then retreated, with yields climbing to around 1.83 per cent, only to fall on Wednesday to nearly 1.7 per cent. They have since rebounded to 1.79 per cent, at time of writing.
Expectations of further monetary and fiscal easing from the Fed are also driving up bond prices, and squeezing yields.
Outlook: Bond prices could surge again following Iran's retaliation to the US air strike.
After the initial shock, global share prices were only going to go one way, with UK, European and Asian stock markets all falling on Monday.
Tuesday was brighter, though, says Fawad Razaqzada, technical analyst at global currency service Forex.com. “The downside has been limited by expectations that raised tensions will actually have minimal impact on global growth.”
Then came Iranian retaliation, with Asian markets falling again, and Europe expected to follow.
Rupert Thompson, chief investment officer at London wealth manager Kingswood, says 2019 was a stellar year for equity markets, with global equities generating a total return of 27 per cent, but do not expect a repeat. “Returns are likely to be considerably lower this year, as last year's gains were in part a rebound from the sharp sell-off in late 2018.”
The lesson from most geopolitical crises of the past is not to overreact, Mr Thompson says. “Equities fell more than 10 per cent after the 9/11 terror attacks but within a month had regained their losses,” he says.
Outlook: Expect a bumpy time for shares, unless corporate earnings surprise by improving. Any short-term correction could be a buying opportunity.
Traditional safe haven the Japanese yen was the immediate beneficiary of the US drone attack and while the Canadian dollar benefited from the rising oil price, the US dollar fell.
Mr Bell says higher oil costs are bad news for India, which relies heavily on imported energy, and the rupee has come under pressure.
Joshua Mahony, senior market analyst at online trading platform IG, says the pound has enjoyed a sharp move higher off the back of a much better-than-expected UK services PMI data for December.
Data improved after the election on December 12, suggesting services will enjoy a recovery as we move into 2020. “There is a hope that the coming months will see traders focus more on the potential UK economic recovery.”
Outlook: Further Middle East tension could revive the yen, while the pound is still the one to watch.
Bitcoin value is flying again. After ending 2019 below $7,000, it has rapidly surged through the $8,000 barrier.
Victor Argonov, analyst at financial broker Exante, says cryptocurrencies have several advantages over gold as a store of value. “They are easy to buy and sell, can be freely traded across borders, and their use as legal tender is increasingly common.”
The big question is whether they can function as a protective asset, retaining their value during crises. They are volatile and prone to crashes, which means your capital could halve in a month, Mr Argonov says, but as users grow, volatility should decrease.
Mr Argonov says the only thing that can seriously undermine them is a complete ban by leading countries, which seems unlikely. “Every year, more and more influential financial communities join the cryptocurrency market, and they would not want to leave it.”
Outlook: Bitcoin is getting harder to dismiss. It may have few practical uses, but neither does gold.