Today one of the greats in the business warned the pullback in the gold market will not be sustained as the price of gold is headed above the $6,000 level.
Opening Pandora’s Box
April 1 (King World News) – John Ing: The consequence is that the president has opened the Middle East’s “pandora box” creating, according to the IEA, “the largest supply disruption in the history of the global oil market,” which could severely damage the global economy. Iran has waged war with the global economy, sowing doubts about the strength of traditional alliances. The US-Israeli war has expanded into a worldwide energy crisis, with the effective closure of the Strait of Hormuz blocking 20 percent of the world’s oil and nearly a third of the world’s fertilizer shipments. Mr. Trump has demanded that countries send warships to keep the Strait open but instead spurned his call and are negotiating with Iran for safe passage of their ships, in a coalition of the unwilling. The disruption to supplies, from wheat to oil, has the potential to spark worldwide inflation, and the increase in rates has already resulted in significant fluctuations in the world’s stock markets. In opening the box, Donald Trump has no means to close it.
America was unprepared, thinking that Iran would be a quick victory. Iran otherwise tested America’s vaunted defense umbrella with an escalating barrage, attacking neighbouring energy infrastructure, depleting America’s and Israel’s multi-million-dollar Patriot missiles tasked to take down their cheap drones which cost a few thousand dollars. Ironies of ironies, the Gulf nations have approached Ukraine for their drone defenses, in a possible swap of Patriots for drones. America can only build about 800 Patriots a year, so allies and adversaries are concerned because of the need to replenish their complex and costly air defenses. America’s Gulf allies are bearing the brunt of Iran’s attacks, so they want a quick end to the war to resume exports because their fuel storage facilities are limited and vulnerable to drones. Similarly escorting ships through the Strait is considered too expensive and risky. Mr. Trump’s golden age is mired in risk and while he likes high risk, high rewards, he has gone all-in. Will the world join him?
Furthermore the longer the war lasts, the more difficult to bring back production as the oil and gas wells will require work to resume production. The costs are staggering with Rystad of Norway estimating the Middle East states face a $25 billion repair bill. Estimates suggest that the war is costing America $1 billion a day with the first six days of strikes estimated to have cost nearly $11 billion, according to Elaine McCusker, a top Pentagon official. The Pentagon has sought Congress for an additional $200 billion to fund the war, which is more than the total cost of Afghanistan and Iraq in 2008, because the conflict also exhausted years’ worth of vital weaponry. With a grip on the Strait of Hormuz and an arsenal of inexpensive drones, Iran is playing the long game. With the cost adding up, energy markets might force Mr. Trump to end his war soon with some 20 countries now militarily involved in the conflict, challenging the economics of Trump’s incursion. The question is, “who will foot the bill”?
Energy Shock Damages Inflation Psychology
Nine oil price shocks have occurred since the Suez Crisis in 1956, four of which have caused market selloffs and a US recession. The roots of the escalating crises go back to the strikes by oil workers who toppled the Shah’s regime in 1978, the first Gulf War in 1991, the second in 2003, followed by 9/11, and the Oct 7 Hamas attack. Here we go again. Oil prices doubled in the 1970s, causing an energy shock as well as a spike in rates and inflation. OPEC was able to weaponize oil thanks to the first Arab oil embargo in 1973–1974, and the Iranian revolution in 1979 which nearly brought the West to its knees, causing another global energy shock. US inflation reached 13.5 percent in 1980, forcing double-digit interest rates. As recently as 2008, oil spiked to $150 a barrel at a time when subprime loans tested the system, as a prelude to the 2008 financial collapse…
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For better or worse Mr. Trump has handed Iran a second weapon along with its nuclear capability, leverage and control of the Strait of Hormuz. History shows that Middle East wars tend to drag on and always risk escalation, particularly when Iran is locked in an existential war for regime survival. Qatar has warned that the bombing of vital gas wells is “dangerous” because Iran’s South Pars is part of the world’s largest natural gas field and an extension of Qatar’s North Field, which helped Qatar supply 77 million tonnes of LNG annually, or more than the combined demand from UK and Italy. A damaged Ras Laffan will cost 17 percent of Qatar’s annual production, underscoring how rapidly the war has spiraled. The Iran war also allows Russia to tighten its grip on energy markets, at the expense of the Gulf states as Russian crude enjoys a $150 million a day windfall, helping fill its war chest with billions.
… The war exposes the vulnerability of global and logistical supply systems, causing another global supply shock. Similar to the spike following COVID-19 or the Russian invasion of Ukraine, there is a chance that supplies of everything from food, to fertilizer, to gasoline will run out during a period of weak global economic growth. In fact, monetary policy continues loose as governments, in particular the United States pursues both a guns vs butter policy that has already morphed into a bond shock, further hurting government finances. The inflationary shock caused by rising energy costs, could be “the straw that breaks the camel’s back,” similar to earlier blowoffs.
As Good as Gold
All this means that cracks are widening as the “everything market” falters, amid credit fears, inflation, tariffs and now a war of attrition. Will the president spend another $200 billion to reopen the Strait of Hormuz that was open only a month ago? The transition in the rules-based world order to disorder has investors seeking hedges and sanctuaries, at the same time an inflation tsunami is about to hit the economy.
In the last two years, the price of gold has doubled. Everywhere in the world, there is a noticeable drop in trust. An alternative to the dollar is gold and the warning signal is quite clear as gold, not government is what we trust. Gold has retained its value for thousands of years, and against this background, gold has become central banks’ second most held reserve asset after the dollar. Markets, it is said, climbs walls of worry. Gold is going to be a good thing to have because what is different today, is that there is more than a single wall of worry.
Until recently gold was on a record-breaking run, topping $5,500/oz. Trees don’t grow to the sky and gold corrected about 25 percent. Still the price is double a year ago, yet the bandwagon is lighter today on the downswing and fears of central bank selling. We disagree and believe that central banks will continue to be buyers. China’s central bank has purchased gold for the 16th conservative month. The centre of gravity for gold and silver has shifted eastward with the Shanghai Gold Exchange becoming the largest gold player in the world. Central banks who were the largest buyers in the past few years are expected to continue to buy gold to protect themselves from the geopolitical threats, inflation and the risk of vindictive sanctions.
Institutional investors while earlier initiated stakes in gold and gold shares are expected to continue to be buyers, because as a percentage of assets, gold remains at historic lows. The primary driver for both is the need to diversify after realizing the folly of leaving everything in the dollar basket. There are also supply problems as supplies of gold become limited because there have been few gold discoveries in part because it can take up to 10 years to build a gold mine. Last year except for a handful, reserves declined while the cost of mining increased. As a result M&A activity has been hot, but like a game of musical chairs, there are so few that are free. Sovereign buyers, like China’s Zijin have been on a buying spree buying Canada’s Allied Gold for $4 billion or $370/oz in-situ P+P reserves. We continue to believe gold’s bull run is intact and that gold will top $6,000/oz.
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