Many of our wise friends have been concerned for years that the world will see another Middle East war. Simultaneously, others who we respect are currently concerned that peace in the Middle East will cause oil prices to fall. Recent news coverage of the Iranian nuclear program has heightened these fears among many investors. Will Iran get the bomb? Will they use their nuclear power rashly? Although we believe that eventually Iran will have nuclear warheads, we believe that sane behaviors will prevail.
Before we do too much worrying about the above outcomes let us look at the winners and losers should there be an outbreak of war in the Middle East.
Who imports oil from the Middle East? We reason that those who import oil from the Middle East are quite vulnerable to higher oil prices and possible shortages in the event of a protracted Middle East conflict with or without nuclear weapons.
Japan, Europe, U.S. and China are the largest developed areas importing Middle East oil. These nations share a common purpose to keep Middle Eastern oil flowing.
WHO BENEFITS FROM HIGHER OIL PRICES?
Russia has recently become the worlds biggest oil producer. Russia is a weak economy with a big deficit which needs oil prices to stay at current levels [approximately $70 per barrel] or to rise if Russia is to balance their budget in 2009/2010. Higher oil prices would be a great boon for Russia.
Venezuela, another mismanaged economy which produces oil, would also benefit. Venezuela has financial problems, and higher prices for crude oil would be greatly to their advantage. Much of their oil is heavier and harder to refine, therefore it sells for a discount to lighter more easily refined Middle Eastern grades of oil.
The oil producers in the Middle East benefit as long as there is no destruction of their properties. The problem for them is that a war in their region could decrease their production over the short or intermediate term and could block transportation routes for their oil to reach market. In our opinion, most Middle Eastern producers sincerely wish to avoid a war in their region.
Clearly, there are extreme groups in many oil producing countries who wish to hurt the oil consumers and would be thrilled to destroy Israel. However, the governments of Saudi Arabia, Iraq, United Arab Emirates, and even Libya, which are the big oil producers in the region, do not want the major oil consumers to be enraged at them, nor do they want war to disrupt their shipping lanes and thus curtail their income. In our opinion, these producers would be happy with higher prices, but not at the risk of not being able to sell or deliver their production.
The exception may be Iran, who is increasing their alliances with Russia to the consternation of the oil-consuming regions.
One big consumer who has not weighed in on the political standoff between the anti-nuclear forces and Iran, but who may be pressuring all parties behind the scenes is China. China is a very big consumer of Middle Eastern oil.
WE BELIEVE THAT MANY OF THE TENSIONS IN THE MIDDLE EAST CAN BE TRACED TO RUSSIA.
Russia wants to increase their geopolitical influence. One way to do this is to work with difficult nations such as Iran, and to make life more difficult for the Europeans, the U.S., and China. Russia is supporting Iran’s nuclear program with technical personnel, selling weapons to Iran and supporting them in world political bodies.
OUR EXPECTED OUTCOME—–MORE TENSION, BUT NO WAR
With four big power blocs against war (Europe, China, Japan, and the U.S.) the only one big power bloc who may be in favor of war is Russia. We doubt that war will occur. Skirmishes may occur and there is the possibility of the bombing of one Iranian enrichment facility by Israel, but we do not believe that the U.S. and other Israeli allies will allow Israel to take unilateral action.
THE MAJOR INFLUENCE ON THE PRICE OF OIL AND OTHER COMMODITIES ON THE WORLD STOCK MARKETS WILL BE THE CONTINUED DECLINE OF THE U.S. DOLLAR
In our opinion, people will flock to stores of value that are priced in U.S. dollars, especially oil and gold to hedge against a weak U.S. dollar. The logic is that if demand remains stable and the dollar falls in value, consumers who buy with other currencies will continue to pay the same number of other currencies as before, allowing the price in U.S. dollars to rise. In the past, a declining U.S. dollar has also caused many investors to buy non U.S. stocks and real estate as a method to diversify while hedging against the U.S. dollar decline.
Certainly, there is a lot of complaining by European nations that the U.S. dollar is too weak and is attaining an unfair trade advantage as a result of its decline. We see this as typical during periods of serious economic decline in Europe. Politicians are desperate to shift the blame for their inept handling of the economic situation to others, and the U.S. dollar is a good proxy.
A big concern of ours is that competitive devaluations may begin as one country after another starts to try to manipulate their currency. We believe that all three of the major currency blocs the Yen, Euro, and U.S. want their currencies to decline so that they may export more. The expected outcome is that they will all stay in a fairly narrow trading range with one another for the next few months as their parent governments manipulate their values in the currency markets. While these three currencies are being manipulated to maintain export parity, we expect the smaller non-manipulated currencies, such as the Norwegian Krone, Brazilian Real, Australian Dollar and Canadian Dollar to continue to rise versus all three of the major currencies.
WILL THERE BE A BIG STOCK MARKET DECLINE IN 2009?
We certainly don’t know about the timing, but we have no reason to expect more than a normal 15 percent correction in U.S. and European stocks over the next few months. A major market decline will not occur, in our opinion, until fear of another banking system collapse returns. If this fear does return, it will be due to a new crisis in the banking system: the crisis will be the result of the behaviors surrounding the current banking system bail out. We believe the bailout of 2008-2009 has created “moral hazard” which will eventually lead to even greater speculation in derivatives, and will eventually lead to new types of risk taking couched in much the same faulty mathematics as the last batch of toxic securities.
Derivatives are profitable to those who create them. The instruments may have big commissions connected to them that are quite opaque to the buyer of the derivative. This makes them immensely attractive to those who create them and the creators are fighting hard to keep their creation as unregulated as possible.
U.S. POLITICIANS WILL NOT REGULATE DERIVATIVES BY REQUIRING THAT ALL SUCH CONTRACTS BE CLEARED THROUGH AN EXCHANGE
We were not encouraged to see that last Friday that the U.S. House of Representatives Financial Services Committee released a draft bill that plans to only mildly regulate derivatives. The politicians are avoiding the strong medicine that former Fed Chairman Paul Volcker has recommended. They are not even agreeing to the much less stringent suggestions of the Obama administration. The draft bill proposes to exempt many of the world’s largest commercial hedgers from processing derivatives through clearinghouses. We believe that this will open loopholes through which speculators and major institutions will get exemptions from requiring their derivative transactions to be cleared through clearinghouses.
Because they are unwilling to take the politically difficult, but in our view necessary regulatory action to avoid a further recurrence of the problem, there is no question in our minds that a new crisis will occur. The only question is, when will it occur? We will monitor the situation and hopefully we will be fortunate enough to again predict when a new type of derivative will bring down the banking system. Our preliminary guess is that it will take a minimum of two to three years for a new crisis to unfold.
We believe that the U.S. dollar will continue to decline in value against the smaller and less manipulated currencies such as the Brazilian, Australian, Canadian, and Norwegian, barring a war in the Middle East, which could offer the U.S. dollar temporary safe haven qualities. In our opinion, to hedge against a decline in the currency, U.S. dollar holders should consider holding oil, gold, and foreign company shares which are not denominated in U.S. dollars.
Our favorite foreign markets are Brazil, Hong Kong, Taiwan, Singapore, and India. Within Europe and the U.S. we favor those companies which can excel in exporting to the fast growing segments of the world. In these regions we would wait for market corrections before initiating large positions. Please do not hesitate to write or call with questions or suggestions.
Thanks for listening.
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