Geopolitical risk matters again. Heres what it means for the markets

In 2017, geopolitical concerns ranging from White House turmoil to North Korea rarely caused more than a ripple in financial markets. In 2018, its a different story as a China-U.S. trade spat and rising tensions over Syria also enter the mix.

At least thats the tale told by the difference in performance by commodities overall, particularly oil, and stocks and bonds, observed economists at Capital Economics, in a Wednesday note.

While Middle Eastern politics and conflict have long been part of the oil market, the return of geopolitics as a driving force even seems to have unsettled some analysts.

As analysts who deal primarily with supply and demand, we feel uneasy at present because the fundamental data are dominated by politics. The current abundance of (bullish) news is forcing us into the unfamiliar role of a political observer, wrote commodity analysts led by Eugen Weinberg at Commerzbank, in a Wednesday note.

Commodity prices rebounded at the start of the month, lifted by concerns over U.S. sanctions on Russia and escalating tensions in the Middle East, despite a flat performance by the U.S. dollar. Only the precious metals subindex, which saw a more restrained rise, failed to jump.

Meanwhile, the return of geopolitical turmoil has led commodities to largely outperform equities and bonds over the last month and since the start of the year, the Capital Economics analysts observed, pointing to the chart below:

The Bloomberg Commodity Index
BCOMSP, +0.65%
is up 2% in April and 1.2% for the year to date, while the S&P 500
SPX, -0.55%
is up 0.2% in April and off more than 1% since the end of 2017.

Stocks have been buffeted by the trade spat between the U.S. and China, often falling on any perceived ramp-up in hostility and, as illustrated by Tuesdays price action, rising on any perceived easing of tensions.

Read: How Chinas Xi, without blinking on trade, got the stock market to cheer

Stocks have also appeared more sensitive to developments surrounding turmoil in the White House, as illustrated by a historic late-session swoon Monday after news broke that federal agents had raided the home, office and hotel room of Trumps personal lawyer, Michael Cohen.

But its the crude-oil market where expectations of an imminent U.S.-led military strike on the forces of Syrian President Bashar al-Assad in response to an alleged chemical attack on the rebel-held city of Douma thats reflecting rising Middle East tensions. Oil traded at its highest levels since late 2014 on Wednesday on fears conflict could lead to supply disruptions.

Brent crude
LCOM8, +0.26%
the global benchmark, is up more than 7% this week, bringing it to a 7.5% year-to-date gain, while the U.S. benchmark, West Texas Intermediate crude
CLK8, +0.42%
is up 10.4% in 2018.

The conflict threatens to spark a wider confrontation between the U.S. and its allies, including Saudi Arabia, and Assads backers, namely Russia and Iran. Trump taunted Moscow in a Wednesday morning tweet, daring Russian forces to follow through on threats to down missiles aimed at Syrian targets.

Russia vows to shoot down any and all missiles fired at Syria. Get ready Russia, because they will be coming, nice and new and smart! You shouldnt be partners with a Gas Killing Animal who kills his people and enjoys it!

— Donald J. Trump (@realDonaldTrump) April 11, 2018

Meanwhile, local news reports that the Saudi military shot down a missile aimed at Riyadh by Iran-backed Houthi rebels in Yemen added to the tensions, and provided a further boost to oil futures.

It is not only the danger of a possible counterstrike by Russia, but also the fear of the U.S. adopting a renewed proactive Middle East policy thats driving crude prices, the Commerzbank analysts wrote. It is also highly probable at present that sanctions against Iran will be resumed or even extended.

Indeed, the replacement of Secretary of State Rex Tillerson with Mike Pompeo and the appointment of John Bolton as national security adviser, both hawks on Iran, are seen upping the odds the administration to end the deal that waived nuclear-related sanctions on Iranian crude exports.

Analysts at Soci茅t茅 G茅n茅rale last week boosted the probability of the renewal of sanctions to 70% from their previous estimate of 50%. They argued the eventual hit to supplies would provide a $10 lift to crude prices, but estimated that around half of that had already been priced in, helping to explain the recent rise.

Capital Economics, however, warned that oil bulls appear extended, with the number of speculative long positions to short positions running at about 13:1 versus 4:1 at the start of 2014 when oil fetched over $100 a barrel. That could lead to an abrupt fall in crude prices if sentiment sours, they said.

Geopolitical tensions in the Middle East are currently supporting prices but we think that growing supply will eventually cause stocks to rise which will drag prices back down by the end of the year, they wrote. Whats more, if tensions ease, prices could drop more sharply than we expect.

All in all, it looks like political analysis and market analysis arent going to be separated again soon.

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