Where Wealth is Built
In a Wednesday article titled, “World’s Largest LNG Plant Suffers Extensive Damage, Qatar Says,” Bloomberg reported that “the complex that houses the world’s largest liquefied natural gas export plant has suffered ‘extensive damage’ after an Iranian attack, hours after Tehran warned of threats to energy facilities across the Gulf.”
The Iranian attack and threats to hit other energy assets were reportedly in retaliation for its giant South Pars gas field being hit by Israel.
The next day Reuters reported that, according to Qatar, the Iranian retaliation had damaged 17% of Qatar LNG capacity for up to five years.
In the same retaliation, Iran also attacked Saudi’s Yanbu port, which is being described by many Western analysts and policymakers as a possible way to bypass the Strait of Hormuz for international oil transports.
In HAI‘s view, this week’s escalation of the conflict illuminates several observations with important subsequent ramifications. First, U.S. defensive missiles are not currently able to completely thwart Iran from landing impactful strategic strikes on select targets. Second, Iran is not out of missiles. And third, it appears that, outside of an imminent negotiated resolution to the conflict, investors should expect the Yanbu port (potential bypass of Hormuz) and other critical energy assets to get damaged or destroyed in the coming days and weeks—as long as the war continues.
That means, outside of an imminent negotiated resolution to the conflict, investors should also expect higher oil prices, higher commodity prices, higher inflation, bond market problems, higher bond yields, a weakening consumer and economy, and stock market problems.
In turn, those noxious ingredients imply the growing likelihood of substantially increased stress on the already critically problematic U.S. fiscal problem and, as a result, the increasing likelihood of some form of yield curve control policy as a bond market necessity.
That would ultimately be very dollar negative, very bad for the role of U.S. Treasuries as global reserve asset, and very, very good for precious metals.
But those very likely eventual market outcomes are not reflected in the current market price action—yet. In HAI‘s view, the reason is simple. The war is bullish for the U.S. dollar—until it isn’t.
At the very same time, the war both strengthens the dollar’s short-term position through traditional crisis demand while simultaneously eroding the institutional foundations that support the dollar’s longer-term strength and dominance.
In other words, in HAI‘s view, the market is currently caught between competing time horizons. The market is seeking dollar safety now and driving the dollar higher. On a longer time horizon, however, the consequences of this war are very likely to significantly weaken the dollar and send gold much higher.
Furthermore, precious metals are getting the significant intermediate-degree correction that has always been a part of even the strongest of bull markets. This correction will ultimately act as the fuel to power the rest of the precious metals bull market that will, in HAI‘s view, inevitably follow.
Now, after eight straight days of an accelerating sell-off in gold, and gold’s worst weekly dollar decline ever, this correction could be about to reverse very soon. Alternatively, this correction could see gold continue lower to test strong support around $4,370/oz, or even tag its 200-day moving average (something that has happened at some point in both of gold’s major post-1971 bull markets) closer to $4,100/oz.
But again, in HAI‘s view, this sell-off will almost certainly prove to be temporary, and likely the last best buying opportunity before the bull reasserts itself.
Now, as for the possibility of an imminent negotiated resolution to the Iran conflict, in HAI‘s view that is also very likely to be bullish for gold and negative for the dollar and Treasuries.
That’s because, in HAI‘s view, the best outcome for the dollar and Treasuries would have been a dramatic and undeniably definitive U.S./Israeli military victory that paved the way for a diplomatic and political victory in which the U.S. reasserted the petrodollar system. But that outcome seems almost entirely out of reach at this point. Besides, in HAI‘s view, this administration understands that a reaffirmed petrodollar is not in U.S. national interests.
So, what might a negotiated peace look like? If HAI were to speculate, it could involve a U.S./Israeli retreat (albeit victory would undoubtedly be declared) and a brokered peace might include Iranian de-facto backers—Russia and China.
That could look something like Iran getting a security guarantee, Russia getting concessions in Ukraine, and China getting as much Mideast oil as it wants priced in yuan (but only as long as those yuan are recycled into gold, not Chinese government bonds—as China doesn’t want to make the same mistake the U.S. made with the petrodollar).
Interestingly, there are some interesting recent signals that just such an arrangement might be in the works. Last Friday night, CNN’s Frederik Pleitgen reported that according to senior Iranian officials, Iran is considering allowing certain oil tankers to pass through the Strait of Hormuz, but only if their cargo is paid for in Chinese yuan.
In HAI‘s view, it seems extremely doubtful that Iran would have floated this idea without China’s knowledge. And crucially, that oil-for-yuan plan sounds an awful lot like policy statements out of the PBOC since as far back as 2015. In June of 2015, at an LBMA event in Singapore, a PBOC representative explicitly noted that the Shanghai Gold Exchange International and gold were both vital to China being able to invoice oil and gas in yuan.
In the presentation, called “World Needs New Reserve Currency,” Dr. Yao Yudong, said:
“The gold market and Shanghai Gold Exchange International are vital to the internationalization of yuan… The key function of an international currency is trade invoicing for commodities like oil and gas… We would like to increase usage of yuan in trade invoicing by using gold.”
Importantly, however, the only way to get yuan at scale is by running surpluses versus China, which almost no country does. So, crucially, this implies that nations would have to buy gold to sell gold to China for yuan (in order to buy oil and get Iran’s permission for its transit through Hormuz). In other words, the CNN story is essentially saying that Iran is demanding gold for oil (thru the yuan China has made easily convertible to gold through the Shanghai Gold Exchange International).
So, in HAI‘s view, whether the U.S. keeps fighting an increasingly likely stalemate over the Strait of Hormuz or makes compromises with dramatic geopolitical consequences to reopen the Strait soon, gold appears set to be the biggest ultimate beneficiary.
In the meantime, we watch the market struggle to navigate the competing time horizons of near-term dollar strength despite the growing promise of longer-term (perhaps dramatic secular) dollar weakness.
That said, the growing gap between a stronger fundamental case for gold and an actual lower gold price is exactly where wealth is built, and we have a rapidly developing wealth-building moment on our hands now. As Warren Buffett famously said, “be fearful when others are greedy, and be greedy when others are fearful.” Right now, precious metals have clearly plunged into the realm of the fearful. In HAI‘s view, we’re rapidly approaching the time to be greedy.
Weekly performance: The S&P 500 was off 1.9%. Gold was hit by 10.52%, silver was crushed by 15.83%, platinum was down 5.98%, and palladium was off 10.54%. The HUI gold miners index was creamed by 14.7%. The IFRA iShares US Infrastructure ETF was off 3.58%. Energy commodities were volatile and lower on the week. WTI crude oil was off 0.63%, while natural gas lost 1.10%. The CRB Commodity Index was up by 0.36%. Copper was down 7.73%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 4.96%. The Vanguard Utilities ETF was off 4.86%. The dollar index was down 0.86% to close the week at 99.50. The yield on the 10-yr U.S. Treasury was up 11 bps on the week, closing at 4.39%.
Have a wonderful weekend!
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
