A roadmap to navigate political tensions

Investors can learn important lessons from the market response to the escalation and subsequent de-escalation of tensions between Iran and the US in the past week. Risk assets fell and safe havens, such as gold, gained as tensions rose, but the market moves were reversed by the end of the week as the threat of military escalation receded.

Whether due to a renewed escalation in US-Iran tensions, or other unforeseen events, geopolitical risks are here to stay. Not reacting in the wrong way to them is crucial to long-term investment success.

Here are our key lessons:

Stay invested.

• Selling on knee-jerk market reactions to political events is generally not advisable. Geopolitical events by their nature are unpredictable, but last week’s events, as well as previous periods of increased tensions, suggest that the impact on wider markets tends to be short-lived. Any more lasting effects tend to be confined to local markets and assets directly affected by the tensions.
• Staying invested through a diversified portfolio to mitigate idiosyncratic risks is the best approach; it ensures a long-term focus in line with your broader financial plan.

Consider protection strategies.

• Investors worried about deploying capital amid heightened geopolitical uncertainty can, however, take advantage of relatively low volatility in the option market at present to make use of strategies that reduce portfolio volatility or add explicit protection. They might increase their diversification via dynamic or systematic allocation strategies, or through structured solutions such as notes that offer a degree of capital protection.

Gold remains a good hedge against political uncertainty.

• As tensions rose last week gold prices briefly climbed above USD 1,600/oz for the first time since 2013. While gold has given back some of its recent gains as tensions have faded, the yellow metal still benefits from fundamental support. Muted US economic growth means real rates are likely to stay low, reducing the opportunity cost of holding gold.
• We also expect the US dollar to weaken this year, which, as bullion is priced in USD, supports gold’s price. Meanwhile Treasuries, including US TIPs, also performed well in the risk-off move.

Middle Eastern tensions don't necessarily imply a major oil price spike.

• Barring severe supply disruption, we do not believe that oil prices can maintain levels above USD 70/bbl, even if tensions in the Middle East continue to simmer. This proved to be the case last September when a Saudi refinery facility was attacked. Spare capacity in oil remains adequate – OPEC's and Russia's spare capacity is around 3.3mbpd. And we still expect an oversupplied oil market, particularly in the first half of the year, due to non-OPEC supply growth (by the US and Norway) outpacing modest oil demand growth.

The economic impact of oil prices is not what it used to be.

• Less oil is required to produce a unit of global GDP today than in the past. In the US, for example, the economy uses only about one-third the oil needed to produce a dollar of GDP in 1973. Global crude production is also more geographically diverse, and the US, the world’s largest oil consumer, is now a net exporter. So even if oil prices were to rise, the wider impact would be less than it used to be.

Navigating geopolitical uncertainty and risks is challenging, but considering these lessons can help investors smooth their investment path.

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