Changes in the situation in the Middle East are constantly disturbing global financial markets. Yesterday, the media said that Israel is determined to fight back against Iran, US stocks and Bitcoin are diving, and gold is rising. The price of gold is close to the record high set last week. At one point, it rose 1.76% above $2,385 per ounce.

Overnight, the three major US stock indexes turned down intraday. The NASDAQ closed down 1.8%, and S&P fell more than 1% on both days, the biggest two-day decline since the Bank of Silicon Valley went out of business. The Dow fell six times in a row.

On April 15, a team led by Citibank analyst Dirk Willer pointed out in a recently released report that the conflict between Iran and Israel is unlikely to escalate in the short term, and the risk of a sharp rise in oil prices is low. If oil prices do not soar, the global market may soon return to the Fed-themed trading model.

However, if the conflict unexpectedly escalates, Citi believes that when investors' risk aversion rises rapidly, gold and yen may be better hedging options:

The most effective hedging tools are usually those whose market positions are biased in the “wrong” direction. In the current environment, shorting USD/JPY may be a better option than going long on CHF.

Gold is generally regarded as a safe-haven asset and often performs well during periods of rising geopolitical uncertainty. Therefore, increasing exposure to gold can also be a hedging strategy for investment portfolios. If the conflict escalates, it will stimulate the central bank's demand for gold purchases, and the price of gold may rise to 3,000 US dollars/ounce early.

Regarding the crude oil price trend, Citi believes that the current crude oil market has absorbed part of the risk premium and raised the short-term oil price forecast from 80 US dollars to 88 US dollars. If the tension escalates significantly, the price of oil may rise to around $100, but this is not a basic scenario assumption.

Goldman Sachs, on the other hand, believes that the current oil price includes a premium of about 5-10 US dollars/barrel. If oil transportation in the Strait of Hormuz is blocked, oil prices will rise 20% in the first month, and if the interruption continues for several months, oil prices may double.

Citi: Gold and yen would be good options to hedge against risk

Citi believes that although the situation is unclear and the situation may change rapidly, key signs indicate that the possibility of escalation is not high. The main channel for the transformation of the Middle East conflict into a global macroeconomic event is often a sharp rise in oil prices. Currently, the risk of a sharp rise in oil prices is low, so the global market should pay new attention to the Federal Reserve's monetary policy.

Citi said, however, that if the situation is tense and the conflict escalates further, Iran's oil production is at risk. The resulting sharp rise in oil prices will mean that the Middle East conflict will become more important to global macro assets, risk assets will be under pressure, and the market will tend to look for assets that can avoid risk. From a fundamental perspective, in typical hedging tools, it is more inclined to spend more yen than Swiss franc. At the same time, going long for gold is also an option:

Increased geopolitical tension may further support the price of gold through demand for safe-haven assets and demand from emerging market central banks to buy gold. Under a bullish scenario, we expect the price of gold to rise to $3,000 per ounce by 2025, and the apparent escalation of the conflict may speed up this process.

Despite sharp increases in nominal and real interest rates, and federal funds rate futures pricing has become more hawkish, the price of gold has soared to record levels in recent weeks. Multiple factors, such as geopolitical hedging, demand to replace fiat currencies, and strong physical demand, have boosted the price of gold in recent months.

The tense situation in the Middle East is likely to spur the long-term trend of emerging market governments buying gold to diversify reserves.

The yen hit a new low since 1990 for 5 consecutive trading days. The cumulative decline so far this year has exceeded 8%, falling to around 154 yen, exceeding the level that some analysts warned might trigger direct intervention from Japan. Analysts said that one important reason for this situation is that recent strong US economic data indicates that the Federal Reserve is delaying interest rate cuts.

Bank of Japan officials previously warned that they are ready to take action to support the yen if necessary. Although the Bank of Japan abandoned its negative interest rate policy last month, since interest rates are still far lower than the US, this has had little effect on supporting the yen.

Some analysts point out that the “safe-haven nature” of the yen is the result of a combination of loose monetary factors and arbitrage transactions in the capital market. Japan's highly sustainable low-interest monetary policy due to a long period of low inflation compared to Western countries was listed as the main reason why it was able to attract foreign capital to invest in its currency during the economic crisis.

However, many analysts pointed out that considering that the Bank of Japan has limited room for interest rate hikes, the spread between the US and Japan may remain high for a long time, and the potential rise in the yen exchange rate is limited, so the “safe haven” position of the yen has been greatly challenged.

Citi: Oil prices may fall in the second half of this year

Citi believes that crude oil prices now include expectations that the situation will continue to be tense. It has raised the crude oil price forecast from 80 US dollars to 88 US dollars per barrel. It is expected that by the third quarter of 2024, oil prices will fall back to the 70-80 US dollar range if the situation eases. If the situation escalates clearly, the price of oil may be close to $100, but this is not the basic scenario:

The tense situation in the Middle East will remain high to support the rise in oil prices. The recent oil price forecast was raised. The 0-3 month Brent crude oil spot price forecast was raised from 80 US dollars to 88 US dollars per barrel, and the average price for the second quarter of 2024 was raised from 78 US dollars to 86 US dollars per barrel.

The market has now priced the ongoing tension in the Middle East region in the second quarter at the level of $85-90 per barrel. If the situation eases in the third quarter, oil prices may quickly fall back to the 70-80 US dollars/barrel range.

If the situation continues to escalate, oil prices may rise above $100 per barrel. It may increase the risk that Iran will partially or temporarily close the Strait of Hormuz, or cause Iran to attack oil facilities in the Gulf region, all of which may further push up oil prices.

Since this year, as tension in the Middle East intensifies, the world's two major energy futures — WTI crude oil and Brent crude oil — have both risen sharply. Last week, the global benchmark Brent crude oil once broke through $92 per barrel and jumped to the highest level since October last year.

Colin Cieszynski, portfolio manager and chief market strategist at SIA Wealth Management, said in an interview with the media that crude oil rose sharply last Friday, and Iran's actions over the weekend “have not actually led to an escalation of the situation so far,” and the market saw some short-term profits come to an end.

Goldman Sachs believes that although the geopolitical risk premium (compensation required by investors for the risk that geopolitical shocks may reduce oil supply) is difficult to accurately determine, based on the pricing framework and hedging costs, the current price is roughly estimated to include a premium of about 5-10 US dollars/barrel, which means that the market believes that the supply will decrease by 4 million b/d within the next 12 months or 8 million b/d within the next 6 months is 15%, and the baseline scenario probability of uninterrupted supply is 85%:

Following the fact that the price of Brent crude oil has just broken through $90 per barrel and that the International Energy Agency (IEA) released higher-than-expected inventory data on Friday, our pricing framework shows that the difference between the 1-month futures price of Brent crude oil and the 36-month futures price (that is, the 1/36 difference) is about $10 per barrel higher than the model forecast.

Goldman Sachs said that although the possibility of oil supply interruptions in the Strait of Hormuz is still very low, if oil transportation from the Strait of Hormuz, which currently accounts for 17% of global oil production, is blocked, oil prices will rise 20% in the first month, and if the interruption continues for several months, oil prices may double.

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