My view is that neither the crises in the Middle East nor the sanctions against Russia should be of concern over the longer term. Even the most dramatic geopolitical events typically have just a short-term impact on markets. However, it is true that there could be more air strikes on Syria by the US-UK-French coalition, and the situation in Syria could get worse before it gets better.
There could also be additional sanctions imposed on Russia. And there is, of course, the likelihood that the US-Iran deal may be killed. In the shorter term, these events would be expected to drive up certain commodity prices such as oil and add to volatility in commodity and currency markets as well as the stock market. (For example, the Indian stock market would likely come under temporary pressure given the economy’s reliance on oil.) But in the medium term, I would not expect these events to have a material effect.
The biggest political concern — protectionism
Also driving commodity prices last week were concerns about protectionism, which drove down zinc prices. And since tariffs were announced on aluminum and steel last month, we have seen those prices rise sharply. That’s a great segue into what I am far more worried about than the crisis in Syria or sanctions against Russia: the potential for protectionism to increase. I understand that investors heaved a collective sigh of relief last week at the conciliatory speech given by Chinese President Xi Jinping at the Boao Forum.
However, I believe it is erroneous to assume that there will be a dialing down of trade tensions. I still believe Xi will not make material concessions in negotiations with the US. And while many were encouraged by news that the US is contemplating re-joining the Trans Pacific Partnership, I would be surprised if that occurs given that the trade agreement has already been negotiated. There’s little reason to believe the parties would make significant alterations to the agreement in order to make it acceptable to the US without requesting concessions in return.
From my perspective, protectionism remains the big risk markets need to be concerned about — and it seems the US Federal Open Market Committee is in agreement given the minutes from the March meeting. Having said that, it is difficult to assess what could happen, although we know that protectionism can have many investment implications.
Because they inject uncertainty into the economic picture, they typically increase volatility in markets. And this particular trade dispute between the US and China could have significant currency implications. Recall that China’s potential weapons are not just tariffs and quotas; it can also devalue the yuan. This would make Chinese goods more attractive to foreign buyers and likely widen the US’ trade deficit with China. In addition, it could impact other Asian currencies.
Where do we go from here?
I must preface my comments by saying that it is very difficult to forecast commodity prices because they are dictated by so many different factors beyond supply and demand, including the strength of the US dollar, government trade policies and speculators.
- I expect oil prices to continue to rise in the near term, driven by the conflict in Syria and the potential for the US to withdraw from the Iran deal, both of which would curtail oil supply. However, it is likely that production would increase in the US and elsewhere to compensate for depressed supply.
- I expect aluminum and steel prices to remain at elevated levels in the near term, with other commodity prices also possibly rising. However, industrial demand appears to be softening, and I believe that could persist, placing downward pressure on prices later in the year.
- My outlook for gold is positive. Greater geopolitical tension, higher inflation and rising protectionism would all be expected to help support demand for gold. And while some believe that gold is being replaced by bitcoin as a go-to, “safe haven” asset, I don’t subscribe to that view.
- Looking at currencies, I would expect continued volatility in emerging markets currencies given that geopolitical crises don’t appear to be moderating any time soon. I expect a strengthening of the Japanese yen as investors look for safety amidst uncertainty.
This article has been republished with permission from Invesco Powershares.