Iran Sends a Warship into the Red Sea (This is How Regional Conflicts Begin)
Welcome to 2024, which already feels like the continuation of a Netflix series.
Portfolio housekeeping note: During the holiday break we exited our short positions in the ARK Innovation ETF (ARKK) and the euro-dollar forex pair (EUR/USD) at their predetermined risk points. (The Decoder model portfolio uses intraday alerts and good-til-cancel stop loss orders to exit a position automatically if a risk point is triggered.)
On the one hand, the frenzied liquidity surge into the end of the year was even stronger than expected — to spectacular blow-out levels — in the aftermath of Yellen and Powell jointly pouring kerosene on a FOMO (fear of missing out) fire.
On the other hand, Apple (AAPL) is down 3.5% on the day as we write — a big drop for the world's most valuable company, which we are still short — on a Barclays downgrade. Meta Platforms (META) and Nvidia (NVDA), two other Magnificent Seven members, are also down more than 3% as of this writing.
This adds to our conviction that liquidity was the story — and continues to be — and that the $64 trillion question is still what happens when the liquidity runs out.
We'll have more on that in the upcoming model portfolio update.
Today, in a world with no shortage of drama, we note Iran has sent a warship into the Red Sea.
Geopolitical pundits still assume the risk of U.S.-Iran escalation is low.
"This Iranian destroyer is just for media consumption," says Dubai-based geopolitical analyst Riad Kahwaji of the Institute for Near East and Gulf Military Analysis, adding that "it is unlikely that this destroyer will confront the Western warships in the area because Tehran does not want to get in a war with the US."
Kahwaji is probably right. Iran would be crazy to want a real war.
And yet we can't help but recall that, prior to Russia invading Ukraine on Feb. 24, 2022, all of the pundits were saying Vladimir Putin would be crazy to take such a bad gamble. He took it anyway.
The odds of a full-blown shooting war are almost always low.
But even a 10% chance means one out of 10 — an achievable result from a single roll of the dice, and with six or seven rolls, a likely one.
Then, too, if Iran does decide to escalate, it likely won't do it by sending the Alborz — the Iranian destroyer that has sailed into the Bab al-Mandeb — directly into harm's way.
Instead, it would more likely shut down the Strait of Hormuz, disrupting the flow of roughly 18 million barrels of oil per day.
Distress Calls and Death by Helicopter
Then, too, the Red Sea conflict has already escalated into a shooting war.
Over the weekend — on Dec. 31 at 6:30 a.m. local time — the U.S. Navy received a distress call from the Maersk Hangzhou, a private container ship, as four small Houthi boats drew close to the vessel and attempted to board it.
The attack occurred 55 nautical miles from Al-Hudaydah near the Bab al-Mandeb strait, as shown via marker on the Google Map image below.
In response to the attack, the U.S. Navy deployed helicopters from the USS Eisenhower and USS Gravely, a nuclear-powered aircraft carrier and an Arleigh-Burke class guided missile destroyer.
After reportedly taking fire from the Houthis, the U.S. helicopters sunk three of the four Houthi boats, killing all of their crew.
This was the event that led to Iran announcing deployment of the Alborz, an Iranian destroyer, to the Red Sea by way of the Suez Canal (near the top of the map, at the north end of the Red Sea).
Iran's deployment of the warship on Monday coincided with a visit by Mohammed Abdulsalam, a Houthi spokesman and negotiator, to Iran's foreign ministry.
Yahya Saree, another Houthi spokesman, confirmed the loss of 10 Houthi fighters in the exchange of fire with U.S. helicopters and said the region should be "ready for all options in confronting the American escalation."
We don't know where this is going — but this is how major conflicts start.
Earthquakes begin with small tremors. Tornadoes and hurricanes begin with high winds. And wars begin with fast-and-loose confrontations that start with low death counts and then spiral out of control.
Nor have we mentioned here that Israel looks ready to escalate in Lebanon.
Shale Versus Shutdown
The increased output of U.S. shale producers has kept the global oil market flooded with supply and all but erased the geopolitical fear premium from the day-to-day crude oil price.
A slowdown in demand from China, coupled with stepped-up U.S. oil and gas output, has also contributed to double-digit percentage oil-price declines in 2023, despite what is happening with Russia and the Middle East.
Here is the thing though: If Iran shuts down the Strait of Hormuz, the oil price could still spike by 50% to 100% overnight.
That is because the immediate loss of 15% to 20% of the world's daily oil supply (via Hormuz shutdown) would instantly swing global oil markets from oversupply to shortage, with extreme impacts from violent market dislocation on top.
A Strait of Hormuz shutdown still has to be considered a low-odds scenario — but the odds are rising.
We are now in 10%-to-20% probability range, or maybe 20%-to-30% range, as the U.S. decides how to handle further disruptions to a shipping lane (the Suez Canal atop the Red Sea and the Bab al-Mandeb at the bottom) that handles an estimated 12% of the world's cargo trade, with Iran deciding how to play its hand in the region, and an Israel-Hezbollah escalation via Lebanon looming in the background.
Against this backdrop we don't know what will happen with oil — the price could credibly touch $60 per barrel or $150 per barrel within the next six months, depending on what actors in the Middle East decide to do — but we very much like the structural outlook for gold (as expressed via gold stocks), which already had multiple factors in favor to start with.
Until next time,
Justice Clark Litle Chief Research Officer, TradeSmith
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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