By Giles Coghlan, Chief Currency Analyst HYCM
Headlines have a habit of turning on a penny. Just as “US China” and “trade war” began to recede as popular search queries, the new year has given us completely new keywords, market movers and geopolitical fears to take into account. But before we get into the nitty-gritty of what has changed over the holidays, let’s take it from the top.
On September 14th, 2019, aerial drones were used to attack state-owned Saudi Aramco (SE:2222) oil processing facilities at Abqaiq and Khurais. The attack temporarily paralysed the country’s oil production capabilities, cutting capacity in half and removing approximately 5.7 million barrels per day, or 5% of global supply, from the market. Iran was widely suspected of having been involved in the attacks, despite not claiming responsibility. The price of crude oil spiked by as much as 15% when trading reopened after the weekend attack.
Fast forward four months to Friday, January 3rd, and news of another drone strike outside Baghdad International Airport in Iraq begins to ripple around the world, followed by images of a car wreckage. It emerges that the strike was ordered by President Trump to assassinate top Iranian General Qasem Soleimani. Before this was officially confirmed by the White House, Trump tweeted a picture of an American flag. Soleimani was killed in the attack, causing all sorts of speculation as to the reasons for the escalation of US tensions in the region. Oil markets reacted instantly, spiking prices 5% and sending oil to its highest level since September 16th.
After a public war of words and exchange of threats, Iran retaliated on January 8th by launching 22 ballistic missiles into Iraq. Trump’s response amounted to little more than a thumbing of his nose at the Iranians due to none of the casualties being American citizens. That same day, in what was originally reported as a completely unrelated event, Ukrainian International Airlines flight PS752 crashed over Tehran. It has subsequently been reported that the plane was shot down accidentally.
One of the narratives that immediately emerged was about how the conflict with Iran was disrupting energy coming from the Strait of Hormuz in the Persian Gulf. The Strait of Hormuz is a 170km long sea passage from the Persian Gulf, south of Iran, into the open ocean, and is regarded as one of the world’s most important resource choke points. A third of all the world’s liquefied natural gas and approximately a quarter of global oil production passes through it each day. According to the US Energy Information Administration (EIA), an average of 22.5 million barrels of oil pass through the strait per day, which is about 30% of all the oil moving over the world’s oceans each day. Of this amount, 80% of that oil is destined for Asia. In other words, the global economy couldn’t function without this supply.
Markets have an uncanny habit of putting narratives to bed though, regardless of how compelling they may seem. West Texas Intermediate (WTI) crude oil prices wavered at the highs set in the days after Soleimani’s death, then on January 8th, promptly fell from a high of $65 to a daily low just over $59.We’re currently testing the 200-day moving average as support in the upper $57s. If you took this data alone, without focusing on the headlines, you might reach the conclusion that the oil markets are distinctly unconcerned about the prospect of WWIII.
WTI barely breaks above the high set in the wake of the Saudi drone strikes, then immediately retraces.
Then again, many of our dearest-held economic assumptions are being challenged in this period of distorted markets and unconventional policy. For instance, super-low interest rates and monetary expansion are supposed to lead to inflation. You’re also not supposed to see a strong dollar, equities at all-time highs, record low-interest rates and gold in a bullish trend simultaneously.
Similarly, unlike the first and second Gulf Wars, the oil market is currently quite oversupplied. The US is now in a radically different situation regarding its oil needs when compared to Middle Eastern conflicts of the past. The US shale oil boom has massively altered the balance of power as now the United States produces almost 13 million barrels of petroleum per day. That’s around 13% of the global supply. Factor in OPEC’s recent cuts and the fact that Russia and Saudi Arabia would love to increase their own supply if they could, and you have to wonder how low oil prices would be right now without Iran being in the headlines.
For oil bulls, technically speaking, if the 200-day moving average holds as support then we could be setting a lower-high at these levels. But the question remains, have markets become complacent? Is this Iran situation as serious as it seems on the surface? An interesting chart to keep an eye on is the spread between WTI and Brent. Brent oil will tend to have a larger Saudi premium priced-in, so any crisis in oil production associated with tensions in the region will quickly be reflected in this spread. This is due to the US becoming a net exporter of oil thanks to its exploitation of harder-to-access shale oil deposits over the past decade or so (another by-product of unconventional monetary policy which has helped finance these costly-to-mine deposits.)
Gold has also been a benefactor of these tensions, having risen to 6-year highs since Soleimani’s death. You’d expect it to appreciate with the kinds of headlines we’ve been seeing since the New Year. However, gold already had a lot going for it irrespective of recent geopolitical tensions. This certainly gave the yellow metal a boost, but there are other underlying factors supporting gold at these price levels. These include the crisis in the repo market – which has fallen from the headlines but is far from over – and a Federal Reserve that appears to be running out of tools as its balance sheet continues to expand. It’s beginning to look like the US rates have further room to fall.
Gold breaks through late 2019’s resistance to set new higher-highs, trades above 20-day moving average.
According to Goldman Sachs (NYSE:GS), gold is currently a better hedge than oil. The bank’s commodity strategists see further upside for the yellow metal while projecting that the risks for oil are “skewed to the downside.” Citigroup (NYSE:C) has also been reported as expecting “stronger for longer” gold prices, citing factors such as the rising risk of global recession and the likelihood that the Federal Reserve is forced to drop US interest rates to zero. In such a scenario, Citigroup’s analysts expect gold to break its 2011 all-time high of $1921 per troy ounce and breach the $2000 level. These are all factors that have contributed to gold’s rise independent of the recent US-Iran escalations.
Just like the Brent-WTI spread is important to keep an eye on in the case of oil, the gold-to-silver ratio is another interesting chart to keep your eye on. Not only is gold looking bullish against USD after having broken all-time highs against many other currencies last year, but gold is also currently trading within 15% of its all-time highs against silver.
The general mood following these shocking events has been defined by calming down and de-escalation. At least that’s the story we’re hearing from Western media outlets. The Iranians fired some rockets because Trump forced their hand, but no one really wants to escalate this situation any further. Whether this is a convenient story to placate the markets remains to be seen. What’s undeniable is that we seem to be adding more factors for global markets to stress over, while making business-as-usual trades look much riskier in this current climate.
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