This report is a breakdown of our on-going research into the situation between the US and Iran. Our focus is on how this is affecting the financial markets and where there may be threats or opportunities.
The points in this article are based on our opinion and areas we see of interest at this point in time — if the situation changes, the points outlined are likely to change as well.
- Tensions between the US and Iran have been escalating since the US withdrawal from the nuclear deal.
- Without the nuclear deal in place, Iran can enrich uranium which is one of the planets most dangerous substances. It can be used to create nuclear explosive devices.
- President Trump ordered the strike on Qasem Soleimani to deter “future Iranian attack plans”, which was a major escalation and rattled global markets.
- Following Iran’s retaliation, the US doesn’t appear to be responding with military force and President Trump has hinted the nuclear deal could still be renegotiated. This has calmed global markets.
- The US says they may introduce more sanctions against Iran which could provoke retaliation.
- Further escalation would add a major risk factor into global markets, however, markets typically recover losses following a pre-war period.
The Big Picture
Tensions between the US and Iran have been escalating since the US withdrawal from the Iran nuclear deal. Without the nuclear deal in place, Iran will be free to enrich uranium.
On 3 January 2020, the US killed an extremely influential Iranian general on Iraqi soil with a missile strike. This created ripples through global markets.
Iran retaliated with a missile strike of their own, targeting three US-Iraqi air bases in Iraq. However, Pentagon officials believe Iran deliberately avoided hitting US personnel and the strike was just to ‘send a message’.
President Trump has said Iran appears to be standing down and vaguely suggested that the nuclear deal could be re-negotiated. Trump claims to seek peace with Iran and this has calmed markets. US stock indices have returned to all-time highs.
However, the US is still pushing ahead with further sanctions and the UK, France and Germany have triggered a dispute mechanism in the nuclear deal which pushes it closer to collapse.
Why This Matters
Without Iran abiding by the terms of the nuclear deal, they will be continuing to enrich uranium. So far there has been limited outrage, as the US has appeared to be the aggressor.
Enriched uranium is one of the most dangerous substances on the planet because it can be used to make nuclear explosive devices. This is why a number of European countries have been trying to mediate between the US and Iran to keep the deal alive.
Following the US strike on Iraqi soil, Iraq has voted to expel US personnel from the country. Iran has been looking to remove US-led forces from the Middle East and this was a personal mission of Soleimani. If this happens, it could give ISIS room to rebuild since the US may also leave Syria.
Iran has a relatively modern military comprised of a Navy, Air Force and Army. This is unlike the war in Iraq, as they had a limited Navy and Air Force. Iran’s military is ranked as 14th in the world and has been described by an American general as the Middle East’s most powerful military force.
Iran also has many advanced missiles which would be a significant threat to US pilots and military installations in the Middle East.
In the case of war, Iran has said they will shut down the Strait of Hormuz. This would have a major impact on oil as 17.2 million barrels pass through it every day. This accounts for 20% of global production.
They may also attack oil installations owned by allies of the US, such as those in Saudi Arabia.
The Trump administration is currently understaffed and those in many positions are inexperienced and underqualified. Record turnover can also create instability as people are unable to build working relationships and gain experience in their position.
Having inexperienced, underqualified and unconfirmed people in key positions dealing with critical foreign policy issues could increase the threat of errors.
Timeline of Events
8 May 2018: The US withdraws from the Iran nuclear deal.
21 May 2018: The US sets out 12 demands that must be agreed or Iran would face economic sanctions. These were rejected by Iran.
7 August 2018: The US imposes the first set of economic sanctions on Iran. These are the sanctions originally removed as part of the nuclear deal, prohibiting trade with a number of business sectors.
5 November 2018: The US announces the second round of sanctions which target oil and banking sectors.
8 April 2019: The US labels the Islamic Revolutionary Guard Corps (IRGC) as a terrorist organisation. This is the first time the US has labelled the military of another country as a terrorist group.
15 April 2019: Economic and travel sanctions introduced for the IRGC.
5 May 2019: The US sends an aircraft carrier strike group and Air Force bombers in response to indications of escalation. There are warnings that any attack will be responded to.
8 May 2019: Iran states it is preparing to increase enriched uranium and heavy water production. The US announces new sanctions targeting the steel and mining sectors.
12 May 2019: The UAE claims four tankers damaged off the coast of Fujairah, this is one of the largest bunkering hubs.
14 May 2019: A drone attack on Saudi Arabia hit a major oil pipeline taking it out of service. Riyadh, a US ally, blames Iran for the attack as they accuse Iran of arming Houthis (which launched the attack). Iran denies the claims.
19 May 2019: A rocket lands near the US embassy in Baghdad, Iraq. Trump tweets that “If Iran wants to fight, that will be the official end of Iran. Never threaten the United States again!” However, there was no clear evidence Iran launched the rocket.
12 June 2019: The Prime minister of Japan goes to Iran to mediate between the US and Iran. Japan urges Iran to play a constructive role for peace although Iran doesn’t consider Trump as a person worthy of exchanging messages with.
13 June 2019: With the Japanese prime minister in Iran, a Japanese and a Norwegian tanker were attacked in the Gulf of Oman. The US fifth fleet receives distress calls from both the tankers.
17 June 2019: The US deploys 1,000 additional troops to the Middle East. Iran also said it was only 10 days away from reaching the limits set by the nuclear deal on its stockpiles of low-enriched uranium.
20 June 2019: Iranian forces shoot down a US military drone. The US claims it was above international waters but Iran claims it was in Iranian airspace.
21 June 2019: Trump says he called off a military strike on Iran in retaliation for the downing of the drone. He signals he is open to talks with Iran.
22 June 2019: Iran says it’s ready to respond to any US threat. Iran also orders the execution of a defence ministry contractor convicted of spying for the CIA. The US says they will impose more sanctions.
25 June 2019: The US introduces new sanctions which target Iran’s leader and associates with additional financial sanctions. Iranian officials claim politicians close to Trump were thirsty for war rather than diplomacy.
29 June 2019: The US Air Force deploys F-22 stealth fighters to the region to defend American forces and interests.
1 July 2019: Iran exceeds limits on its enriched uranium stockpiles.
4 July 2019: Royal Marine Commandos, police and customs seize a supertanker in Gibraltar carrying Iranian crude oil to Syria in breach of EU sanctions.
8 July 2019: Iran passes a new nuclear deal limit which reduces compliance with the accord.
12 July 2019: Police arrest the captain and chief officer of the seized tanker in Gibraltar.
19 July 2019: The IRGC seizes a British ship in the Strait of Hormuz. Iran claims it failed to respect international maritime rules.
25 July 2019: The Royal Navy announces they will escort all British flagged ships through the Strait of Hormuz.
1 August 2019: The US imposes sanctions on Zarif (Foreign Affairs Minister) for acting on behalf of Khamenei (Supreme Leader).
15 August 2019: Iranian seized tanker is released, although the US was attempting to keep the ship detained.
23 August 2019: Iran reveals a new missile defence system.
26 August 2019: Iran holds talks with France at the sidelines of the G7 summit. They say they are pursuing constructive engagement.
30 August 2019: Iran further exceeds nuclear deal limits, increasing its stock of enriched uranium and refining it to a greater purity. The UN’s International Atomic Energy Agency confirms Iran is backing out of the pact in retaliation to the US’s withdrawal from the accord and imposed sanctions.
3 September 2019: The US introduces sanctions on the Iran Space Agency, Iran Space Research Center and the Astronautics Research Institute as they claim they were being used to advance the ballistic missile program.
4 September 2019: The US blacklists an oil shipping network that they accuse of being directed by the IRGC and supplying Syria with oil. The US also throws out a proposal from France to throw a financial lifeline to Tehran.
5 September 2019: The US offers several million dollars to the captain of an Iranian tanker suspected of heading to Syria if they deliver the tanker to somewhere it can be seized.
7 September 2019: Iran begins injecting gas into advanced centrifuges to increase their stockpile of enriched uranium. They also warn time is running out to save the nuclear deal.
10 September 2019: Trump fires National Security Advisor John Bolton, as Trump strongly disagrees with the easing of US sanctions on Iran.
14 September 2019: Houthi rebels claim responsibility for drone attacks on two Saudi Aramco oil facilities. The attacks take out more than half of crude output from the world’s biggest supplier. The US blames Iran, although there is a lack of evidence the strike came from Iran or the Houthi rebels.
24 September 2019: Trump lashes out at UN General Assembly, telling other countries to tighten the economic noose around Iran.
4 November 2019: The US imposes more sanctions on the inner circle of the Supreme Leader, including one of his sons. Nine people are sanctioned and Iran’s Armed Forces General Staff is blacklisted.
6 November 2019: Iran begins the process of injecting uranium gas into centrifuges at its underground Fordow facility.
7 November 2019: A US-led coalition launches operations in Bahrain to protect shipping in the Gulf following previous attacks which were blamed on Iran. The US secretary of state accuses Iran of preparing a rapid nuclear breakout.
8 November 2019: Iran claims it downed a foreign drone. The US confirms it was not one of theirs.
15 November 2019: Iran raises fuel prices by 300%, causing unrest in over 100 Iranian cities.
22 November 2019: The US imposes sanctions on Iran’s Communication Minister for widespread censorship.
25 November 2019: Iran accuses the US, UK, Iraq and Saudi Arabia of stoking unrest in the country.
27 November 2019: Iran arrests eight people with links to the CIA.
4 December 2019: The US Navy seizes advanced missile part on a boat in the Arabian Sea believed to be linked to Iran.
7 December 2019: The US and Iran cooperate and exchange prisoners.
8 December 2019: Iran announces a $39bn budget of resistance to counter US sanctions and reduce hardships. The budget includes a 15% wage increase for public sector employees.
11 December 2019: The US Treasury imposes new sanctions on Iran’s biggest airline and shipping industry citing the transport of lethal aid to Yemen.
19 December 2019: The US restricts visas for Iranian officials for suppressing peaceful protests. The US also sanctioned two judges.
27 December 2019: An attack on an Iraqi military base killed a US contractor and injured several US and Iraqi service members. The US blames Hezbollah for the attack, an Iranian-backed militia.
29 December 2019: In response, the US strikes sites belonging to Hezbollah in Iraq and Syria. At least four commanders were killed along with 25 fighters and 55 were injured. Iran condemns the attacks.
31 December 2019: Members and supporters of pro-Iranian paramilitary groups storm the US embassy in Baghdad. The US blames Iran for ensuing tensions around the embassy.
2 January 2020: US Secretary of Defense says Iran or supportive groups are planning additional attacks on US interests in the Middle East.
3 January 2020: A US strike kills Iranian general Soleimani. Iran vows harsh retaliation.
5 January 2020: Iraq passes a resolution calling on the government to expel foreign troops from the country.
8 January 2020: Iran fires a number of missiles at three US-Iraqi air bases as retaliation for the killing of Soleimani. Many commentators suggest this is less than proportionate to the killing of a general, suggesting Iran is attempting to avoid direct conflict. Trump claims Iran appears to be standing down, which is a good sign that he is not intending to take further military action. However, he announces there will be more sanctions.
10 January 2020: The US imposes new sanctions on Iran that target multiple sectors, including construction, manufacturing, textiles and mining. They also name eight top officials, some of which are already under sanction and could be a sign the US is running out of targets.
14 January 2020: The UK, France and Germany trigger the dispute mechanism in the nuclear deal in response to Iran’s decision to breach its uranium enrichment limits. The move pushes the deal closer to falling apart and could lead to the reimposition of UN sanctions.
Reactions in the Markets
The threat of war between Iran and the US sent oil prices upwards as Iran hinted it would close the Strait of Hormuz and analysts predicted Iran could target oil installations. This bullish surge was soon faded and oil prices have now seen a sharp bearish reversal.
The US State Department has warned of a “heightened risk of missile/drone attacks” particularly in Saudi Arabia, which is responsible for around 12% of total global oil production.
Saudi Aramco, Saudi Arabia’s state-owned oil company saw its share price drop more than 10% from its peak as a result of the uncertainty in the Middle East, including the strike on the Iranian general. This left the company trading at its lowest price since its IPO.
Saudi Aramco was the target of a drone strike in September 2019. The damage from the drone strike cut about 5% of global oil production, which destabilised global markets. Houthis claimed responsibility for the attacks but Saudi Arabia and the US blame Iran — Iran has denied its involvement.
The shipping industry is also concerned about attacks in the Persian Gulf, as there have already been attacks in the past year. Once again, Iran has denied its involvement so far.
Commerzbank said, “If Iraq were to plunge into chaos, up to 4 million barrels per day could be at risk. Even Saudi Arabia could not plug such a big hole. A risk premium on the oil price is therefore justified,”.
With the risk of chaos on the horizon, oil companies in Iraq have begun to increase security. Americans have been advised to leave the country and oil giant Chevron is reportedly evacuating non-Iraqi staff from Kurdistan.
So far no oil has actually been taken offline. Therefore, although the elements for higher prices are in place, according to Goldman Sachs “Absent a major supply disruption, we therefore believe that price risks are skewed to the downside in coming weeks, with oil prices already trading above our fundamental fair value of $63/bbl ahead of the recent events.”.
OPEC is also sitting on a large amount of spare capacity, with an estimated 2mb/d available for immediate production. Any higher prices could also incentivise US shale companies to increase output, although there would be a lag time.
We also cannot ignore the demand factors. If we do see higher prices once again, it could lead to subdued demand undercutting the rally. However, as we have already seen, if disruption is largely priced in already, prices are likely to fall back.
Following Iran’s retaliatory missile strike, WTI jumped 4%, however, after the US response appears to de-escalate the situation, WTI was trading lower than before the initial strike on Soleimani.
Gold and Other Precious Metals
Gold rose to the highest price since 2013, as investors sought safe-haven assets as a hedge against geopolitical risks. Gold may prove to be a better play than oil for any tensions in Iran.
A further escalation in tensions between the US and Iran could, therefore, lead to more upside for gold. Although, when trading is light, such as during Christmas and New Year, markets can often overreact. As liquidity comes back to the market in January, price reactions may become more subdued.
UBS has stated that they expect the value to remain in gold as negative real rates in the US and a weaker US dollar favours stronger precious metal prices in general.
Gold stocks also rose on the escalation, such as Newcrest Mining which was up 3.9%.
Following the apparent de-escalation from the US, the price of gold is heading down again but not by as much as we have seen with oil.
Other precious metals have also benefited from the current geopolitical risks. This includes Palladium which is at all-time highs. The metal is in heavy demand relative to supply as it is used in autocatalysts which reduce vehicle emissions.
Silver is also on the rise, however, Platinum saw a decline.
Stocks fell broadly on the news of the US strike. Technology, financial and healthcare stocks accounted for much of the decline, however, energy and defence sectors saw gains, as would be expected.
The yield on Treasurys fell from 1.88% to 1.79% which can lead to lower mortgages and consumer loans. Bank stocks fell following the escalations in Iran, but have since posted earnings reports which featured a record year for JPMorgan. Banks will also be gaining from the Federal Reserve’s involvement in money markets, which may help to offset any negative sentiment.
As history suggests, any decline in the stock market is likely to be short-lived and in this case, it didn’t take long for markets to bounce back.
Following de-escalation, the S&P and the DOW have bounced back both creating or testing new highs.
Two of the main risks for equities in recent times have been the trade war between the US and China and the Federal Reserve reducing its balance sheet and raising rates (which it has now reversed course on). The rising political tensions in the Middle East have now added another major risk.
Additionally, North Korea has said it is no longer halting major missile tests and will soon show off its “new strategic weapon”. This may lead to more concerns there, which have been subdued recently.
In 2011, researchers at the Swiss Finance Institute found that throughout history the pre-war phase usually sees a decline in stocks. When war eventually does break out, unless it’s a surprise, stock prices will typically increase. This is referred to as “the war puzzle”.
An analyst at JPMorgan has also suggested that investors are able to shrug off major events much easier, having seen the stock market recover from the 9/11 attacks and the financial crisis; two of the biggest geopolitical and economic shocks of our time.
USD/JPY saw whipsaw action following the retaliation from Iran. Amongst other reasons, this could be due to investors seeking safe havens and the unwinding of carry trades.
Areas of Opportunity
Defence and Aerospace
In the past, defence stocks have posted better returns than the S&P for six months following the eruption of major conflicts such as:
- The first Gulf war in 1990
- 9/11 attacks and subsequent invasion of Afghanistan in 2001
- The invasion of Iraq in 2003
JPMorgan noted that “With so many unknowns, however, we are reluctant at this time to embrace last week’s U.S. strike as an opportunity to buy Defense stocks more aggressively with a longer time horizon.”
Before previous wars, defence stocks were typically trading at a discount to the market, however the current discount isn’t as large as in previous periods. This means, the starting valuation is higher and there may be less upside.
The S&P 500 Aerospace and Defence Industry Index gained 1.5% following the US strike.
- Lockheed martin +3.6%
- Raytheon +1.5%
- Northrop Grumman +5.4%
Boeing is one company we are taking a closer look at. The price has been severely hit due to poor shipments in 2019, months of bad press and operational difficulties due to problems with the 737 Max.
The company has a large defence division which produces a wide range of military aircraft and ammunition, including missiles. Since Iran has air capabilities along with SAM missiles and a navy, the defence branch of Boeing may benefit from further escalation in the middle east.
Other companies which may benefit from a sustained war effort:
- Alliant Techsystems — Ammunition
- General Dynamics — M1 Abrams tank
- L-3 Communications — Recon, detection and comms systems
- Lockheed Martin — Fighter jets
- Northrop Grumman — Fighters and bombers
- Raytheon — Cruise missiles
- United Technologies — Black Hawks
During times of war, we may expect increases in the defence budget. The US has recently passed the most recent budget which is almost at record highs, however, the Pentagon can also ask for funds through the Overseas Contingency Operations account which does not count towards the cap.
There are also companies that may benefit from supplying Iran, such as Huawei Technologies which upgraded Iraq’s air defence between the Gulf Wars. However, Huawei is not publicly traded and may cross ethical boundaries for some people in any case.
Iran is very capable in cyber warfare and attacks are likely to increase. The Governor of Texas, Greg Abbot, reported that Texas has seen a spike in cyberattacks and faces 10,000 potential cybersecurity attacks per minute from Iran on state agency networks.
A number of cybersecurity companies have already seen stock price rises in anticipation of cyberattacks such as:
- Crowdstrike Holdings +11%
- FireEye +5%
The Department of Homeland Security has issued warnings telling businesses and organisations to take precautionary measures.
Cybersecurity expert and engineering professor Justin Cappos has also recommended that companies and individuals protect vital systems by maintaining external backups, software updates, having strong passwords and two-factor authentication.
He sees the Internet of Things (IoT) devices as particularly enticing targets as they can cause physical damage. This can include medical devices, vehicles, power grids, election systems and home devices. Anything that has been automated could be a potential target for a cyberattack.
Iran has been known to go after both government and civilian targets — although critical infrastructure and large organisations are more likely to be targeted than your Alexa!
A New York Federal Reserve analyst report said “We estimate that the impairment of any of the five most active U.S. banks will result in significant spillovers to other banks, with 38% of the network affected on average. … When banks respond to uncertainty by liquidity hoarding, the potential impact in forgone payment activity is dramatic, reaching more than 2.5 times daily GDP,”. This shows how cyberattacks on critical industries, such as the US banking system, could have a devastating effect on US financial stability.
There have been cases of banks being affected by cybersecurity attacks on third parties. One example includes Travelex, the world’s largest foreign exchange bureau, which was attacked by ransomware on New Year’s Eve. Some of the biggest banks in the UK such as RBS, Lloyds, Barclays and HSBC were unable to process foreign exchange requests for their customers.
In the past, Iran has prefered what’s known as “wiper” attacks. These are attacks that delete information on the systems they infect rather than stealing files or holding them for ransom. These attacks became less frequent in the US after the nuclear deal, but IBM has announced these were still widespread in the Middle East during 2019, with targets such as Saudi Arabia.
Biotech industries create vaccines and treatments that would help prepare for biological warfare and terrorism, however, they can burn through a lot of cash with no guarantee of success, often making them a risky play.
- Baxter International
- Human Genome Sciences
If attacks do take place, there will be a need for rebuilding infrastructures such as roads and oil structures.
For example, Fluor is bidding on a $600 million contract to rebuild infrastructure in Iraq. Halliburton is also a leading contractor for oil infrastructure.
Oil & Oil Firms
If the situation continues to escalate, Iran is likely to target US installations in the Middle East, such as US energy producers, or installations owned by allies of the US, like Saudi Aramco in Saudi Arabia.
Iran has previously stated it would close the Strait of Hormuz, where more than 20% of the world’s total oil production passes through.
Any hint of closure to the Strait of Hormuz would undoubtedly cause oil prices to increase. However, the US Navy has vowed to keep the Strait open and if Iran tries to close it, they are likely to put themselves into direct conflict with the US.
Around 76% of the oil that passed through the Strait of Hormuz in 2018 went to the Asian markets. This means their economies may bear the brunt of any escalation in the Persian Gulf.
Countries particularly at risk include:
- China, at around 36% of imports or 28% of consumption.
- India, at around 57% of imports or 53% of consumption.
- Japan, at around 83% of imports or 66% of consumption.
- Korea, at around 72% of imports or 77% of consumption.
Oil firms which do not pass through this point and with limited exposure to the Persian Gulf, such as those who extract in the US, will likely increase output and make the most of increased prices.
Oil companies with limited exposure to the Persian Gulf that have seen gains:
- Marathon Oil
Companies that operate in this region may see a negative impact, such as those in Iraq where US citizens are being asked to leave such as:
This may only be negative in the short-term, as they find locals to replace foreign workers and over the longer-term, they would be likely to benefit from higher prices.
Cyclical stocks are likely to be negatively impacted, such as airlines and automotive companies.
After the drone attacks on Saudi Aramco facilities in 2019, the company was looking to insure its facilities against future attacks through Lloyds of London and other London based insurers.
Currently, they insure most of their facilities through their own captive insurer, Bermuda-based Stellar Insurance.
Other companies in the area have been looking to insure against war and terror such as Saudi Petrochemical. Insurance broker Aon also confirmed that they are receiving more enquiries as to whether domestic and international companies were covered against attacks.
Companies such as Saudi Basic Industries Corp have also been looking to include cyber insurance.
Following the tanker attacks in the Strait of Hormuz last summer, insurance rates increased 10-fold in the following two months to transit through. Every ship requires various insurance such as war-risk cover when entering high-risk areas, there is also a breach premium.
During the first Gulf War, airlines were hit particularly hard due to soaring jet fuel costs which more than doubled. The threat of ground and air war also created traffic problems and trans-Atlantic traffic fell 50%.
The FAA has already suspended flights over the Persian Gulf due to increasing military presence and the risk of misidentification.
Some airlines have already seen their price fall, although not yet significantly.
Bitcoin surged to $8,000, a gain of 7.3% following concerns of an escalation. Could Bitcoin be the newest safe-haven asset?
Shipping firms are charging a premium to move oil through the Persian Gulf which will increase profitability, as long as they don’t incur additional costs due to negative events, such as losing any ships.
Some major firms, such as Petrobras and Bahri, have gone as far as to suspend shipping through the Straits of Hormuz due to concerns of military escalation in the area.