Navigating the volatile world of geopolitics deterioration

31 January 2020

6 minute read

By Henk Potts, London UK, Senior Investment Strategist

Gold and oil prices have already spiked this year as sparks flew in the Middle East. With more geopolitical trouble likely this year, do allocations to gold and oil make sense?

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.

Disruption in the Middle East was one of the factors that propelled the price of Brent up 37% in 2019

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.

In order to justify a gold price significantly above $1,600 in 2020, there would need to be a significant worsening in the political and economic outlook

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.

Gold can insure against increased uncertainty

Market Perspectives February 2020

Barclays Private Bank investment experts highlight our key investment themes. Despite a strong start to 2020 by financial markets, trade tensions and rising geopolitical risks feed into a general feeling of apprehensiveness.


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