Navigating the volatile world of geopolitics deterioration

The world has had to live with hostilities in the Middle East for many years and is likely to do so for many years to come. This inevitably leads to short-term gyrations in financial markets and in particular the prices of gold and oil. Investors should have a strategy in place to understand the drivers of both commodities and protect their portfolios from the resulting instability.

Middle Eastern sparks

In our Outlook 2020 we suggested that this year would be characterised by uncertainty. One area we identified that uncertainty would emanate from is geopolitical tensions and specifically the Middle East. This prediction came to fruition much quicker than expected.

Global risk sentiment was at elevated levels in early January following America’s decision to kill Iran’s top military advisor, Qasem Soleimani, and Iran attacked two US military facilities in retaliation. As news of the military action filtered through to investors, it sent a tremor through financial markets. Equities traded sharply lower, Brent surged above $70 a barrel and gold pierced the $1,600 an ounce level for the first time since 2013.

The skirmish between the US and Iran quickly developed into the biggest foreign policy test for Donald Trump’s administration. Ultimately, as the US sustained no loss of life in the attacks and Iran stated it was not seeking war, President Trump summarised that Iran had stood down thereby precipitating a de-escalation in tensions.

The lower risk environment helped stock markets to recover and oil and gold to ease back from elevated levels. However, unprepared investors could have easily fallen into the news cycle snare, encouraging them to drastically alter their positions.

Crude’s climb is likely to be contained

Disruption in the Middle East was one of the factors that propelled the price of Brent up 37% in 2019.  Supply concerns surged following Iran’s seizure of tankers in the key shipping lane of the straits of Hormuz, the attack on Saudi Arabia’s oil production facility, as well as US sanctions on the exporting of Iranian oil.

Energy markets have also reacted to lower production from the distressed producers of Libya and Venezuela along with OPEC+’s, that is the 14 members of the Organisation of Petroleum Exporting Countries plus allied producers, decision at the end of last year to increase and extend production cuts.

While a rise in the price of crude might seem inevitable over the next few months, there are a range of downward price pressures. Analysts have been reducing their demand growth expectations for oil due to moderate global growth forecasts. Energy markets have also had to calculate the impact of rising US production levels. The US recently became the world’s largest oil producer, overtaking Saudi Arabia. The US Energy Information Administration forecasts that the US will produce a record 13.3m barrels per day (mbpd) in 2020.

Supply and demand dynamics for oil in 2020 point to a market in reasonable balance. Current economic conditions suggest an increase in demand of 1.3mbpd in 2020. Rising production from Canada, Brazil and Norway along with the US suggests non-OPEC supply growth of 1.7mbpd. This points to an average price of $62 a barrel for Brent, and $57 for West Texas Intermediate, in 2020. Periods of unrest may result in extreme fluctuations in energy prices, but these are likely to be short lived.

Gold: the ultimate safe-haven asset

Deteriorating international relations are often the catalyst for investors to seek shelter in safe-haven assets. For many investors gold continues to be the “insurance” of choice. This was in evidence last year as investors reacted to a broad range of risks by adding 10.3m ounces last year into gold exchange traded funds (ETFs), with total gold held by ETFs rising by 15%. These investment flows helped the gold price to climb by 18% in 2019.

The price of gold is supported by lower interest rates and central bank purchases. Lower interest rates help compensate for holding a zero interest-bearing asset. Central banks, have increasingly looked to gold to help diversify their holdings away from the US dollar.

Rising investment demand and central bank diversification has helped to offset lacklustre demand growth for jewellery, as well as rising production and recycling levels. In order to justify a gold price dramatically above $1,600 in 2020, there would need be a significant worsening in the political and economic outlook; possibly coupled with concerns of debasement and a weaker dollar as was the case in 2011.

Gold’s attraction as a safe-haven asset remains debatable. Bullion is devoid of inherent characteristics which uniquely qualifies it as the ultimate store of value. However, if enough people believe it, it starts to generate its own reality.

Over long periods of time gold has proved to be a hedge against inflation. However, for most investors gold should primarily be used as a diversification tool. Gold should help to preserve wealth during times of turbulence, rather than be considered a driver of performance over prolonged periods.

For longer term investors, the best way to traverse periods of financial market dislocation is through a globally balanced, diversified portfolio. Investors should remain cognisant that most flare-ups tend to be more limited in scope than the original headlines might suggest.

Staying invested, harnessing gold’s insurance properties and looking for opportunities of mispriced crude are the key to navigating the volatile world of geopolitics.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This document has been issued by the Investments division at Barclays Private Banking division and is not a product of the Barclays Research department. Any views expressed may differ from those of Barclays Research. All opinions and estimates included in this document constitute our judgment as of the date of the document and may be subject to change without notice. No representation is made as to the accuracy of the assumptions made within, or completeness of, any modeling, scenario analysis or back-testing.

Barclays is not responsible for information stated to be obtained or derived from third party sources or statistical services, and we do not guarantee the information’s accuracy which may be incomplete or condensed.

This document has been prepared for information purposes only and does not constitute a prospectus, an offer, invitation or solicitation to buy or sell securities and is not intended to provide the sole basis for any evaluation of the securities or any other instrument, which may be discussed in it.

Any offer or entry into any transaction requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding transaction documents. Any past or simulated past performance including back-testing, modeling or scenario analysis contained herein does not predict and is no indication as to future performance. The value of any investment may also fluctuate as a result of market changes.

The value of any investment may also fluctuate as a result of market changes.

Neither Barclays, its affiliates nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation..

This document and the information contained herein may only be distributed and published in jurisdictions in which such distribution and publication is permitted.  You may not distribute this document, in whole or part, without our prior, express written permission. Law or regulation in certain countries may restrict the manner of distribution of this document and persons who come into possession of this document are required to inform themselves of and observe such restrictions.

The contents herein do not constitute investment, legal, tax, accounting or other advice. You should consider your own financial situation, objectives and needs, and conduct your own independent investigation and assessment of the contents of this document, including obtaining investment, legal, tax, accounting and such other advice as you consider necessary or appropriate, before making any investment or other decision.

THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.