Starting to Reassert Itself
This week, a Financial Times article titled “World faces gas supply cliff-edge as Gulf’s final LNG shipments approach ports,” painted an ominous portrait of a burgeoning global supply chain breakdown—yet to fully manifest.
Another FT article titled, “Iran war is the greatest threat to global energy ‘in history’, warns IEA,” also spotlighted the still underappreciated global crisis that is brewing and continues to worsen every day the Strait of Hormuz remains closed.
According to the FT, Fatih Birol, Executive Director of the IEA, said that the loss of a fifth of the world’s oil and gas flows was “the greatest global energy security threat in history” and that it could take six months or longer to fully restore oil and gas flows from the Gulf (presumably after the Strait is actually reopened).
As HAI has said many times, energy is ultimately a critical input cost for almost everything. As a result, energy prices are the great inflation force multiplier.
Now, the shutdown of Hormuz isn’t just causing an energy supply problem, it’s also affecting the available supplies of agricultural fertilizers, petrochemicals, inputs to plastics, industrial materials (such as aluminum and steel), and specialty commodities like helium (crucial for semiconductor production) and sulfur (for fertilizer production and mining).
In short, given a pending global supply chain crisis set to impact the availability and, by extension, the prices of myriad critical industrial inputs, and an energy price inflation force multiplier in full melt-up mode, expect already above-target inflation to start marching distinctly higher all over again—and soon.
Again, the reality of an incoming inflationary wave is especially true, the longer the Strait of Hormuz remains closed. In HAI‘s view, that could be quite a while.
This week, in an article titled, “Iran’s attacks force US troops to work remotely,” the New York Times reported that Iranian ballistic missiles have left U.S. military bases in the region “uninhabitable.” According to the Times:
“Many of the 13 military bases in the region used by American troops are all but uninhabitable, with the ones in Kuwait, which is next door to Iran, suffering perhaps the most damage.
There were close to 40,000 U.S. troops in the region when the war started, and Central Command has dispersed thousands of them, some to as far away as Europe, American military officials said. But many have remained in the Middle East, although not on their original bases, military officials said. The result, according to current and former military officials, is a war that is much harder to prosecute.”
Now, while remote work is a rapidly growing modern phenomenon and a genuine gift of technology, some industries are better suited to use it than others. To put it mildly, in HAI‘s view, warfare is not exactly the ideal setting for effective remote work. That truth underscores the last line from the NYT’s quote; “The result, according to current and former military officials, is a war that is much harder to prosecute.”
Furthermore, Iran is continuing to fire missiles and drones at a steady pace of roughly 20-30 missiles per day, confounding some expectations for Iran to have already run out. At the same time, the U.S. and Israel are reportedly running low on interceptor missiles. And despite fewer missiles being fired than at the start of the conflict, according to a Bloomberg article titled “Iran’s long-range missiles taking greater toll,” Iran’s missile hit-rate has been rising significantly, as the U.S. and Israel run low on interceptors.
In other words, many of the U.S. military’s bases across the Mideast are reportedly “all but uninhabitable” because the U.S. cannot provide reliable air defenses for these bases, and that situation is still getting worse, not better.
The simple truth, in HAI‘s view, is that as long as Iran is capable of inflicting significant damage to U.S. bases in the Middle East, they are also certainly capable of firing enough missiles and drone swarms to keep the Strait of Hormuz closed.
Of course, the U.S. could employ boots on the ground to try to open the Strait with an overwhelming display of force, but that path carries tremendous risks that, for now, HAI assumes the U.S. administration would seek to avoid.
In the meantime, with the Strait remaining closed, energy prices spiking, and supply chains breaking down, we are likely only three to four weeks from a cascading economic and financial market crisis.
That, after all, appears to be the Iranian strategy. Maintain the ability to keep the Strait of Hormuz closed just long enough for the consequences of that closure to land a devastating economic and financial hit to the West sufficient to bring Washington to the negotiating table—from a position of weakness.
As of this week, we can already see early signs of just this trajectory. Energy prices have seen one of their biggest one-month spikes ever, the stock market is starting to pick up downside momentum, and this week the U.S. had three extremely weak U.S. Treasury auctions, indicating that buyers have already started to back away from the U.S. bond market.
As HAI has said previously, if continued, that combination of toxic ingredients will create a vicious cycle culminating in a stock market rout, bond market implosion, and a runaway government debt spiral.
In such a circumstance, policymakers would almost certainly be forced into emergency policy responses that, while aimed at temporarily stabilizing the system, would also annihilate the purchasing power of the dollar and dramatically undermine the dollar’s global reserve role.
An important Wall Street Journal article this week titled, “American credibility is on the line in Iran,” summed up the current U.S. predicament very well. The Journal equates the risk of the current U.S. engagement in Iran to the 1956 “Suez crisis” for Britain and France after the pair mobilized against Nasser’s Egypt to undo the dictator’s nationalization of the Suez Canal.
Back then, Eisenhower and the U.S. represented the new global power, and that new power reacted harshly to the old powers’ initiative and directed its allies to back off or face full economic pressure from Washington.
As the WSJ op-ed put it, “The lesson for the U.S. lies in the way Eisenhower’s threats demonstrated Britain’s and France’s fundamental lack of credibility. The Suez moment marked the psychological transformation of two erstwhile great powers into medium powers with limited ability to influence the world around them. The U.S. faces a similar risk today.
The market plays the role of Eisenhower, the U.S. that of the French and British embarked on a strategically sound but difficult campaign in the Middle East. Quitting the war while leaving Iran with the ability to seize control of the Strait of Hormuz, and thereby able to shut down global oil supply, would destroy American credibility.”
So unless the U.S. manages to open the Strait very soon, it seems, the U.S. may be forced to negotiate a ceasefire with Iran (and Iran’s de-facto backers China and Russia) without having gained control of the Strait of Hormuz. Regardless of what the U.S. administration calls it, that will likely be interpreted as a U.S. strategic loss to Iran (and its Chinese and Russian backers). And that will very likely dramatically accelerate a global transition to a multipolar system and a multipolar global monetary system that increasingly uses gold as the neutral reserve asset.
If the U.S. doesn’t negotiate and continues on its current path, it must open the Strait very soon or suffer a debilitating financial/sovereign debt crisis that would force policymakers to sacrifice the dollar to temporarily stabilize the system. That outcome would also very likely dramatically accelerate a global transition to a multipolar system and a multipolar global monetary system that increasingly uses gold as the neutral reserve asset.
HAI desperately hopes for a softer, gentler, and more favorable resolution to the current situation, but the situation doesn’t look great. HAI hopes with the best of them, but hope is not a strategy. We must analyze objectively to prepare for the possibilities ahead.
The silver lining in all of this is that, if the U.S. doesn’t open the Strait on its own terms and soon, gold is very likely to perform exceptionally well.
Last week, HAI described gold as being temporarily caught between competing time horizons. In the short-term, a liquidity squeeze and risk-off flight to dollars have weighed on gold, but in the longer term the dramatically bullish fundamental implications of gold’s unfolding dynamics will cause a global scramble into gold. In HAI‘s view, that’s likely to be a scramble the likes of which has never been seen before in the freely traded gold era.
Importantly, we may not have to wait long for that scramble into gold. As Saxo Bank Head of Commodity Strategy Ole Hanson observed this Friday, “It’s very early days, but the price action seen so far today could indicate we are seeing the first signs of gold starting to reassert itself, not just responding to energy prices like another risky asset.” On Friday, for the first time since the war started, gold decisively decoupled from falling stock indexes and a broad risk-off trade to rise alongside surging energy prices. As Ole said, its “early days,” but, in HAI‘s view, he is correct. Gold is showing the first signs of “starting to reassert itself.” HAI expects much more gold reassertion to follow in time.
Weekly performance: The S&P 500 was off 2.12%. Gold was up 0.47%, silver gained by 3.42%, platinum was down 5.71%, and palladium was off 3.94%. The HUI gold miners index was up 7.14%. The IFRA iShares US Infrastructure ETF was up 2.46%. Energy commodities were volatile and mixed on the week. WTI crude oil was higher by 2.19%, while natural gas lost 2.22%. The CRB Commodity Index was off by 1.42%. Copper was up 1.86%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 0.95%. The Vanguard Utilities ETF was up 2.82%. The dollar index was up 0.48% to close the week at 100.12. The yield on the 10-yr U.S. Treasury was up 5 bps on the week, closing at 4.44%.
Have a wonderful weekend!
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
