Friday, 10th of January 2020
”You can’t do a damn thing!”
– Ayatollah Ali Khamenei
(After Trump threatened to retaliate for the US embassy attack)
The new year has started off with a bang as simmering US-Iran tensions exploded to the fore last week. On Friday, a US drone struck a convoy carrying Iranian Major General Qasem Soleimani and the Iraqi politician and Shia militia leader Abu Mahdi al-Muhandis to Baghdad airport, killing both men instantly. Iran and America had been trading barbs since a US airstrike killed 25 members of an Iranian proxy militia in Iraq on 29 December and the US embassy in Baghdad was subsequently attacked with petrol bombs. President Trump accused Iran and Soleimani’s elite Quds Force, which is a special operations unit within the Iranian Revolutionary Guard Core (IRGC), of directing the embassy attack and promised that Iran would ‘pay a very big price’ as a consequence. That price appears to have been the General’s life. Soleimani was one of the most powerful – and popular – figures in Iran and his death marks a new low in fast-deteriorating US-Iran relations. Indeed, his funeral was so well attended that, tragically, some 50 people died in a stampede amid the crush of emotion in his hometown of Kerman. The outpouring of grief and anger was similarly strong in parts of Southern Iraq where Soleimani is seen by many as a hero of the fight against Islamic State, even if Iran’s continued meddling is a divisive political issue.
Iran’s immediate response to Soleimani’s death was to use their influence in the Iraqi Parliament to get legislation passed that calls for US troops to leave the country as soon as possible (although whether, when and how this withdrawal may happen is unclear). Over the weekend, Iran also announced that it would no longer respect limits on the number of centrifuges it uses to enrich uranium under the JCPOA. This decision may well mark the death knell of the signature nuclear agreement. Finally, Iran launched a barrage of 22 ballistic missiles at two US bases in Iraq, 17 of which hit their intended targets but none of which caused any casualties thanks to US early warning systems. Amid the mayhem, it now appears that a civilian plane on route to Kiev from Tehran was accidentally and tragically shot down by Iranian anti-aircraft guns and was not a coincidental victim of engine failure as Iran continues to claim. With no US lives lost, Trump was measured in his response to the strikes: announcing additional sanctions on Iran but otherwise drawing a line under the grim events that have marred the start of 2020. Iran too looks keen to step back from the brink, claiming that the strikes conclude its retaliation for now. Iran also forced its Iraqi proxies to acquiesce in this decision despite their initial enthusiasm for retribution of their own. In time, more attacks on US and coalition forces in the Middle East are likely and the new head of the Quds Force has promised ‘harsher revenge soon’. However, this revenge is likely to take a less brazen and more asymmetric form than Wednesday’s strikes.
Going forward, although General Soleimani was the principal architect of Iran’s bloody regional strategy, the regime is unlikely to change its approach after his death. Iran’s core foreign policy of incubating and arming proxy militias in weaker neighbouring states to create leverage and wield power has been highly effective, while successful interventions in Iraq and Syria have helped to embedd Iranian influence over structures, parties and personalities in both countries. Why would they change this winning formula? The answer is that they won’t, particularly with hardliners empowered by recent events. Meanwhile, the JCPOA is hanging by a thread. As such, we expect tensions to remain high across the region this year.
So, what are the implications for investors? Well, with such an uncertain geopolitical backdrop we are pleased to have our portfolio hedges in place. The US-China phase one trade deal is due to be struck next week (with negotiation of a phase two deal to begin immediately) and we thus see every reason to remain invested in equities. Nevertheless, a Middle East conflict is a tail risk from which we want to be protected. Given persistently low volatility in recent months, such protection remains cheap to get.
We also continue to favour a significant allocation to gold. The precious metal was up +18.3% last year as loose monetary policy and geopolitical volatility drove inflows; and gold has continued to climb since the start of 2020 even while risk assets have rallied, peaking at 1610 after Wednesday’s attack before falling back to ~1550). Negative rates, trade disputes (between the US, China and EU), and the flare up of conflict in the Gulf are all themes likely to play out in 2020 – and push gold to new highs.
Given the locus of geopolitical strife in the Middle East, the coordinated decision by OPEC and leading non-OPEC producers to cut production in Q1, and the stabilisation of global growth at non-recessionary levels, the oil price should also remain supported this year. Interestingly, Brent is actually down -4.4% so far this week despite all the drama: it jumped +3.6% after the US airstrike on Friday before retracing -4.2% when both sides took stock in the wake of Iran’s response. This price action shows the complex interplay between expectations and events and confirms that while oil may rocket if a US-Iran war is declared, the geopolitical heat is already supporting the price and is likely to keep it range-bound in the mid-60s space for the time-being.
From all of us at Bedrock, we wish you a very happy and prosperous new year!