Gold & Oil Prices Tumble As Middle East War Premium Risk Evaporates

The recent nosedive in gold prices can be attributed to the sudden evaporations of the Middle East war risk premium. As a result, gold may become increasingly more sensitive to movements in U.S. yields and the strength of the dollar in the short term. If gold's typical inverse correlation with the U.S. dollar persists and real interest rates continue to rise, bullion prices could experience further declines in the short term.

 Additionally, recent buyers who entered the market during the past week or so and chased gold prices higher are likely feeling unsettled by the sudden drop and may be compelled to sell their positions, compounding the downswing.

Gold and oil often react to scary-sounding headlines from the Middle East, especially when there's a weekend gap risk involved, as seen two Fridays ago before Iran attacked Israel.

Given the significant impact of geopolitical turmoil on macro-policy and rates, it's reasonable to expect oil and gold to be more sensitive to geopolitical developments in 2024 compared to the pre-pandemic period.

The question arises: should oil and gold be sold after geopolitical risk starts to ease? 

The answer is nuanced. While geopolitical events with limited contagion implications historically offered selling opportunities for bears, it's essential to approach this cautiously and consider the broader context.

Geopolitical risks seldom have long-term implications, but this strategy has significant caveats these days.

The geopolitical landscape of 2024 is undeniably inflationary, complicating the market's ability to maintain the notion that there's no direct link to macroeconomic conditions, policy decisions, and, ultimately, higher discount rates. Theoretical limiting both gold and oil price gains unless, in the case of oil, there is an absolute supply disruption. Then, all bear cases are off the table.

It's not just the Middle East; a significant conflict is unfolding in Eastern Europe, adding to the global uncertainty. The Kremlin's response to the promise of new aid to the country Russia is attempting to conquer ( Ukraine) could heighten tensions further.

In such a climate, my preferred strategy leans towards VIX calls or S&P puts, given the volatility and uncertainty and a bit cheaper strategy.

I'm price agnostic, as we buy gold monthly(I have been rebalancing total profits into gold); however, gold investors should take advantage of buying opportunities presented by dips, especially if they seek long-term hedges rather than immediate speculative gains. The world is not a safe place right now. . Central bank buying is a crucial backstop, with physical gold likely in high demand, especially in Asia.

 The ballooning U.S. deficit presents another compelling argument for holding gold, especially as the US Treasury goes further down the Ponzi scheme road than ever before, jeopardizing future generations. As the pile of paper assets grows, there's a looming risk that it could overwhelm the market, potentially destabilizing the global economy. In such a scenario, gold is a hedge against currency devaluation and financial instability, protecting investors seeking to preserve wealth amid uncertain times.

What's often overlooked is that when central banks purchase gold, it's typically stored in vaults, rarely seeing the light of day for decades. This can lead to a shortfall in gold supplies, further bolstering its value over the long term. As a side note, Aisa demand is predicated on a hedge for the local currency devaluations. There is much talk about the PBoC letting the Yuan float on a weaker tangent.

The recent conflict in the Middle East has undoubtedly exacerbated tensions in an already volatile region. While the recent attacks have been downplayed, the potential for further escalation cannot be entirely dismissed. However, there's a lesson to be gleaned from this situation, particularly in how swiftly demand responded to higher oil and gasoline prices, as evidenced by the increase in U.S. oil stockpiles.

Amidst the uncertainty surrounding crude oil prices, our assessment suggests that Brent crude will likely stabilize around $85 per barrel. This outlook reflects a balanced perspective on both upside and downside risks, especially considering that current oil price levels are likely aligned with the preferences of major oil producers like Saudi Arabia. This equilibrium represents a desirable scenario for OPEC+ as it seeks to avoid demand destruction that could result from excessively high prices.

While the possibility of further escalation in Eastern Europe and the Middle East remains a key factor driving upside risks in the oil market, downside risks are increasingly prominent. These risks primarily revolve around the potential for the market to be flooded with excess supply.

Despite the remarkable cohesion demonstrated by OPEC+ since the onset of the pandemic, tensions within the cartel persist, leading to voluntary cuts by certain members. Notably, the UAE has expressed eagerness to ramp up production. The unity of the cartel largely depends on Saudi Arabia's willingness to continue shouldering a significant portion of the cuts, currently accounting for 3.1 mb/d of the total reduction of 5.6 mb/d.

Saudi Arabia's commitment to the production cut strategy is driven by its extensive, long-term investment efforts to diversify its economy. However, concerns about the potential loss of market share, particularly to U.S. shale producers, may prompt the kingdom to reconsider its stance on cuts.

Furthermore, there's a substantial risk that non-OPEC+ production could exceed expectations, especially with U.S. shale producers continuously improving drilling efficiency, primarily through adopting more extended horizontal wells.