Iran’s retaliatory missile attack on US forces based in Iraq prompted gold and oil prices to spike dramatically on Wednesday, but investors believe there is more to the jump than simply fears over escalating risk of war.
Oil hit $71 a barrel and gold demand reached fresh highs after Iran fired “tens of rockets” at bases holding US troops in retaliation to the US air strike on 3 January that killed Iranian general Qassem Soleimani.
The oil price rise was short lived as it soon fell back to about $69, while gold continued on an upward trajectory touching $1,600 per troy ounce before trading back marginally lower at $1,580.
Geopolitical risk not being priced into oil
Wisdom Tree associate director, research, Mobeen Tahir notes the Brent crude price has actually been steady since the initial jump from $66 to $69 in reaction to Soleimani’s death. The fact Wednesday’s revenge attack by Iran failed to materially move the price leads Tahir to believe geopolitical risk is not being priced into oil.
He says in September last year, when Saudi oil facilities were the subject of drone attacks, oil spiked by around 10% and then retreated very quickly in the subsequent days.
“What we’ve seen is that every time there has been a geopolitical incident, oil has spiked and then returned very quickly to the pre-spike level. What that tells us is that a geopolitical risk premium which should be there in oil prices, is not.”
“Whether or not markets actually move to do that is another matter,” he adds. “But we don’t believe that at the current level markets are fully appreciating or pricing in the level of risk in the region.”
Knee-jerk reactions tend to mean revert
Canaccord Genuity Wealth Management chief investment officer Michel Perera says geopolitical events will always move markets but knee-jerk reactions tend to revert to the mean after the situation calms down.
He adds: “Unless this leads to a ground war between the US and Iran, which is extremely unlikely, the current tension may well be seen as an opportunity to add to markets that otherwise could look a little pricey.”
Perera says it is supply that determines a longer-term price move. Price spikes due to events have more chances of sticking when supply is already weak, he says.
“In that respect, given that crude oil output has been falling in the past few months, there is a chance that Brent might trend toward the $70 level and stay there. From an investor’s perspective, though, since 2015, there has been more of a small positive correlation between oil prices and equities, probably due to the lesser dependency of the world economy on oil prices.”
Broaching $100 would spark recessionary fears
Psigma Investment Management head of investment strategy Rory McPherson says oil at about $70 is not an issue for the market but if it continues to spike in the short term, touching $100, then that could reignite recessionary fears.
“Although there’s been some action taken, the economy isn’t roaring ahead so that dynamic would tip us back into starting to worry about recession again and central banks may be thinking about needing to cut interest rates further,” he says.
‘War threat’ is not what is causing gold to rise
Perera does not think markets will be derailed by the current tensions, as the fundamentals, including central bank support, US-China trade deal, strong services PMIs and earnings growth, are still a tailwind for risk assets.
“The exception here is gold, which may well continue to rise even after the geopolitics has calmed down, due to central bank purchases and low interest rates,” he adds.
Similarly, Ned Naylor-Leyland, manager of the Merian Gold and Silver fund, says the rising US dollar gold price is symptomatic of a falling real yields rather than the threat of conflict in the Middle East.
“If the situation should worsen, and that leads to an acceptance of further loose monetary and fiscal policy in the US, we would expect a falling US dollar real yield environment, giving renewed, and sustainable, impetus to monetary metals prices,” he says.
“The rising US dollar gold price is therefore more a reflection of the possibility of lower real yields than a rising ‘war risk’. The bond market perceives a greater risk of rising core inflation and of increased central bank balance sheet expansion due to this worrying situation and that is the primary driver of monetary metals prices.”
Gold remains safe haven of choice
Tahir says gold reflects the geopolitical risk premium much better than oil because speculative positioning rises, and that supports prices.
“Gold continues to keep going up and up. So, what that really is telling us is that gold is being perceived as a safe-haven asset investors are turning to for hedging this risk.”
Wisdom Tree has seen flows into its gold ETFs and leveraged oil products on the back of developments in the Middle East, but some investors have taken profits on the price spikes.
Investment platform Interactive Investor notes Blackrock World Mining Investment Trust as its third best-selling product over 6 and 7 January, while two exchange traded products investing in gold are in the 10 best-selling ETPs this week: iShares Physical Gold ETC in third and Wisdom Tree Physical Gold in fifth.
