By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Do not be misled by the euphoria on Wall Street, the mini-crash in West Texas/Brent/gold, Trump’s boast that Iran “is standing down” so all is hunky-dory in the Middle East. Ayatollah Khamenei has sworn to expel the US from the Middle East – “standing down”? Iran has launched a ballistic missile attack against the American military in Erbil and Al Assad/Anbar air force base in Iraq and publicly acknowledged it. This is unprecedented and thus a game changer. Ballistic missiles are not peashooters, RPG-7 bazookas or even Katyusha rockets but weapons of high tech warfare, lineal descendants of Hitler’s V2 missiles that killed thousands of civilians in the London Blitz. Iran’s ballistic missile program will now be in the crosshairs of the Pentagon, Israel’s IDF and the militaries of the Arab world most threatened by its existence.
This will mean a quantum change in international relations since the Pasdaran/IRGC can precision target missile launchers as it proved in September against Saudi Aramco’s oil processing hub in the Eastern Province. These attacks were not psychological or symbolic but battlefield weapons targeted at the United States and the kingdom of Saudi Arabia, using weapons with a range of 1250 miles that can deliver a lethal, even nuclear payload. This is taboo red line for Washington, Tel Aviv, Cairo and Riyadh. So where is the Middle East headed – war or peace? Whatever Trump’s reassuring boasts, Uncle Sam can no longer allow the existence of Iran’s missile arsenal to threaten and terrorize the Middle East from Haifa to the cities of the Gulf with its Shahab, Fateh, Zulfiqar and Emad nuclear capable missiles. That much, at least, is certain.
The waiting game in the deadliest crisis in international relations since the March 2008 US invasion of Baathist Iraq now begins. EU foreign ministers met in Brussels. Britain and Germany moved diplomats and military advisors from Iraq to safer locales in Jordan and Kuwait. Iran’s withdrawal from the 2015 nuclear deal means inevitable UN sanctions. The Pentagon airlifts the 82nd Airborne Division to Iraq and the Fifth Fleet goes on battle alert in the Gulf. I desperately hope I am wrong but I see no real sign of de-escalation in the US-Iran crisis, not even a feeble attempt at diplomatic mediation by Moscow, Paris, Berlin or Beijing. Are we sleepwalking into another war in the Middle East – the Third Gulf War? Is this the end of the nightmare or just the beginning? I am an investment strategist and equity/FX investor, not a geopolitical oracle (ORCL is at 54.20 though!).
Yet it is undeniable that a potential US-Iran war is now a factor in the global capital markets. The obvious safe haven assets to war are gold and crude oil/energy stocks in this milieu, recommended multiple times in my articles in November and December. Uncle Sam IOU’s, more politely known as the US Treasury bills, notes and bonds are also safe havens for some investors but pointless for me since I expect the US Dollar Index sag to 94 – this is happening. So I hedged market risk by buying high beta drillers/wildcatters in the West Texan Permian Basin, whose shares went white hot when Brent went ballistic (literally so when Mideast cold wars go hot). This is the reason Hess, Conoco Philips, Apache are up 25% since late October.
Another war hedge is to buy Big Oil/Seven Sister supermajor shares – BP, Royal Dutch and the biggest, lowest beta risk puppy of them all, John D Rockefeller’s Exxon Mobil (“put a tiger in your tank” as my Esso tiger face mask when I was 8 used to proclaim).
Exxon Mobil trades at 18 times earnings, offers a 5% dividend yield and a natural hedge to oil price falls due to its chemical refining businesses. Exxon is 69.20 as I write, modest in a 66 – 84 range in the last twelve months. The catalyst? The grapevine in Wall Street contends that Exxon will respond to higher cash flows from the spike in Brent/West Texas to raise its dividend by 5% and resume share buybacks for the first time since the 2014 oil crash to me. Bingo! This means no brainer risk reversal option trades on Exxon can easily generate a 20% total return even if war morphs in to peace. Note that the energy sector is a mere 4.5% of the S&P 500 index and was 13% in 2007 – this means Wall Street institutions are dangerously under positioned in what could be the best performing index sector in 2020 – it was the worst in 2019 and the entire 2010-20 decade. How many bad guys did Obama drone in Afpak? Six time the number of Bush’s black warrant Predator/Reaper victims. Rise and shine, O progressive Dems, you have nothing to lose buy your hypocrisy in this Goebbelsian world where lies, if repeated often enough, become the truth! I wonder if the left realizes that President Trump just won reelection last week?
Another war hedge idea? If the Iranian take revenge on the US military, a $2 trillion high tech machine that can unleash hell on the mullahcracy of Qom/Tehran. Wall Street will scramble to protect a trillion dollar at risk by buying S&P 500 in put options and Volatility Index (VIX) calls, the ultimate fear trade. Where do S&P 500 index and VIX options trade – the exchange where Manju and I trade almost daily. The Chicago Board Options Exchange (CBOE), whose shares trade in New York. If you believe this waiting game will culminate in a hot war, the shares of the CBOE on the stock exchange will skyrocket (bad pun)! The best way to hedge war risk would be to buy risk reversal options spreads on the CBOE – on the CBOE! What else can I do in a world gone mad? What else can I do but mourn the death of the innocent and re-read Count Leo Tolstoy’s epic tale of Napoleon’s march to Borodino and Moscow in that fateful freezing winter of 1812, in a world without CNN or Fox News or ballistic missiles – the lovely, magnificent “War and Peace”.