“The markets, like skilled chess players, are constantly strategizing and making moves based on their perception of the war, revealing a captivating dance between optimism, caution, and uncertainty.”
We aren’t geopolitical experts and do not know how the Israel-Hamas war will unfold. Nobody does. There are too many unknowns at this stage for even the geopolitical experts to do anything other than guess. However, we can analyze what the markets are currently discounting, or what the majority of market participants currently believe will happen. This information is crucial for making decisions in the markets.
Here’s what we think is priced in right now:
1) The oil market: At the time of the Hamas attack on Israel, the oil market was slightly oversold due to a price plunge over the preceding week. Consequently, at least a countertrend rebound was likely regardless of news. The rebound in the oil price from its pre-war-news low looks more like a countertrend reaction than the start of a move to above the September-2023 high. Also, the extent of the backwardation in the oil futures market has decreased over the past week, which suggests less urgency to stock up on physical oil. In summary, the oil market does not believe that the war will have a significant negative effect on global oil supply.
2) The gold market: Prior to the war news hitting the wires, the gold market was very oversold in both momentum and sentiment terms and therefore was poised for a rebound. The performance of the US$ gold price indicates that large speculators initially were uncertain as to how big the war would become. Would it be confined to Israel versus Hamas in/around Gaza, or would it expand to encompass direct involvement from the US and Iran? At the moment, large speculators in the gold market believe that these are open questions, with a substantial expansion of the war being one of the more likely scenarios. The gold price continues to hover around resistance at US$1980-$2000, about $180 above where it was three weeks ago. If the gold price breaks above US$2000, it would indicate a significant increase in perceived uncertainty/risk.
3) The stock market: In the US stock market, the war has prompted a shift away from risk but has been a secondary issue. The primary issue is the downward trend in the bond market (the upward trend in long-dated Treasury yields).
4) The currency market: The Dollar Index (USDOLLAR, DXY) was very overbought in early-October and had just begun to ‘correct’. The war news may have reduced the magnitude of the correction, but up until now has not been sufficient to propel the DX above its early-October high. According to the currency market, the outbreak of war in the Middle East has increased the attractiveness of the US$ relative to other fiat currencies but also added to concerns about the pace at which the US government is going into debt.
In summary, the oil market is not concerned about a significant supply disruption, the gold market has priced-in considerable uncertainty/risk and could price-in more of the same before reversing, the US stock market is more concerned about bond yields than the Middle East, and the currency market thinks that the benefits of holding the US$ in a period of increasing geopolitical instability are being mostly offset by the likelihood that a further increase in geopolitical instability would accelerate the already rapid pace of US government deficit-spending.
