April 2024 - Banyantree Update: Middle East Tensions
Geopolitical events such as wars are commonplace unfortunately and something investors will need to constantly grapple with when setting their short-term and long-term investment strategy. Given the recent escalation in tensions in the Middle East involving Iran and Israel, it may be worthwhile providing investors historical context on how markets have behaved during past geopolitical events which may assist in how to think about the current situation.
+ What is the magnitude of geopolitical events on stocks? The short answer is, on average, not that much. Bloomberg collated data from 18 geopolitical events since 1940 which resulted in the decline in the S&P 500. On average, the total drawdowns from these events were -5.4% and it takes approximately 15 days for the S&P 500 to bottom out.
The other key point to note from the data across these 18 geopolitical events is that the biggest drawdowns in S&P 500 took place in the U.S. Terrorist Attacks, Iraq Invasion of Kuwait, North Korea Invades South Korea and Pearl Harbor Attack - which all resulted in the U.S. going to war. During these episodes the S&P 500 saw double digit price declines and a longer recovery path. With the U.S. just coming out of the debacle that was Afghanistan, our view is that the U.S. does not have the appetite for another drawn out war. In fact, most global economies including Europe, UK – key allies of the U.S. – and China do not currently have the economic strength to withstand a widespread conflict. Most developed economies are still battling high inflation and low economic growth outlook. Europe has a growth problem along with energy reliance on the external world. China also imports a large part of its oil requirements from the Middle East and higher prices are not in China's interest.
We believe the U.S. will make all efforts to avoid escalating the situation and going directly into war with Iran - not at least until after the election even if you take an hawkish approach to the situation. Don't be surprised if the intelligence agencies, top diplomats and military generals on both sides of the divide talk more to each other than teenagers do with their parents. U.S. strategic oil reserves are low and the U.S. is moving into peak demand season with spring and summer. President Biden isn't exactly enjoying stellar ratings - especially on foreign policy. Plus Iran could inflict a 1970s style oil price spike by cutting off global oil supply through the Strait of Hormuz (between the Persian Gulf and the Gulf Oman) - this is a key choke point for global LNG / oil supply.
+ Wars & commodities - where is the hedge? The data on major wars going back to 1800 suggest commodities provide a great hedge. Since 1800, there have been five major global wars – the War of 1812, the U.S. Civil War, World War I, World War II and peak Cold War in 1973-74. According to the study conducted by Thunder Said Energy, during all of these major conflicts, 95% of the commodities experienced higher prices. Further, no surprise that commodities which saw the largest disruption in supply also experienced some of the largest gains to their respective prices.
Fast forward today and whilst we appreciate that no two conflicts are likely to be identical in nature, the supply of critical commodities will continue to attract a premium and hence investors will again find a good hedge against wars in commodities. Even without a war, governments have moved to shore up supply of critical minerals which assist with their energy transition strategy and are key inputs in technological innovation.
+ Underinvestment in certain commodities could come back to haunt. What we do know is that over the recent past there has been a material underinvestment in new supply across some commodities - in part driven by the shift to renewables. This is especially true for fossil fuels such as oil and coal, which still power much of the global economy. Hence further shocks – that is potential disruption from wars - to existing supply could create challenges.
+ Potential Investment Idea. Investors looking to play the broader commodity complex can look at Global X Bloomberg Commodity ETF. The ETF, trading under the code BCOM, provides exposure to a liquid, well-diversified basket of hard and soft commodities which are significant to the world economy and have low correlation with other major asset classes. BCOM invests in a highly liquid, broad-based basket of commodities, including energy, grains, precious metals, industrial metals, softs and livestock. BCOM should trade in line with the Bloomberg Commodity Index (chart below blue = BCOM ETF / white = Bloomberg Commodity Index).
Source: Bloomberg
Apart from the above, we have been advocating for gold for some time now via a simple ETF Global X Physical Gold ETF (GOLD) which is up + 22% YTD\ (performance below). Gold's spot price is fast approaching the US$2,500 level we have been saying for several years now.
