Gold and oil shine

Summary: Threats of a trade war, or even a real war, have helped gold and oil gain this week and even bring back memories of the Cold War. The global outlook might have suddenly shifted.

Key take-out: Gold and oil have picked up points this week, two commodities that are usually signals of trouble ahead. It's important to put this in context and zero in on four key points over the past month.

Against a wall of red ink which showed tumbling share prices on every stock market in the world last week, there were two green lights blinking for commodities that bloom in a crisis – gold and oil.

Rather than fall like equity markets, gold and oil have both gained ground this month.

Gold is holding above $US1340/oz, while on conversion to Australian dollars it has moved above $A1750/oz thanks to the slide in the value of the Australian dollar against the US greenback.

Oil has eased, but on March 27 remained above $US70/bbl as measured by Brent quality crude, the European standard.

The common cause for almost everything that happened on financial markets last week was fear of either a full-blown trade war, or worse still, a real war in one of the global hotspots such as Korea or the Middle East. Worries about Russia were bringing back memories of the Cold War.

For investors, the bounce in gold and oil is a clear signal of trouble ahead, as is the fall in another commodity regarded as the bellwether of industrial production – copper.

As economic and political uncertainty has evolved over the last 30 days, the copper price has fallen by 7 per cent from $US3.21 a pound to $US2.97/lb. It is the first time since late last year that copper has dipped below $US3/lb.

Politics, more so than economics, is driving markets today. Rapid changes in US Government policies and personnel has rattled investors. A swelling response to Russian meddling in the affairs of other countries has shaken European markets.

For Australian investors, the outlook has grown cloudy. The equity market here is almost a mirror image of New York. Both the Dow Jones Industrial Average and the Australian All Ordinaries index are down in the past month.

The flight to gold

Meanwhile, gold has lived up to its role as a balancing agent, offsetting declines elsewhere with the price of the metal rising and the ASX gold index holding rock solid.

Interestingly, the gold index could be higher if not weighed down by the effect of Newcrest's problems at its Cadia mine in NSW, a tailings dam rupture which has knocked 8 per cent off the company's share price. This fall has a significant impact on the gold index because Newcrest is Australia's biggest gold producer.

Other leading gold stocks, including Evolution, Regis, Northern Star and OceanaGold are all up strongly.

Oil stocks have been mixed however, with Woodside and Santos creeping higher, while Oil Search and Beach Energy have eased. Oil Search has been hit by a production setback similar to what hit Newcrest – an earthquake close to its major producing asset.

Four points are worth noting from what's happened over the past month.

• Politics have displaced economics as the market driver, for now.
• Investing in an uncertain political climate is more difficult than investing in times of shifting economic fundamentals.
• Gold is playing its traditional sheet-anchor role by simply being a store of value and a currency largely beyond the control of governments, and
• Oil, despite being in abundant supply, is reflecting the potential for diplomatic conflict to turn into military conflict.

Everything that's happening in equity and commodity markets is about investors trying to assess risk and assign capital to asset classes that can benefit from a period of change, or at least not fall too far.

Right now, the trade war is more a phoney war because of the way threats of high tariffs have been progressively walked back, especially by the US where politicians on both sides are urging greater caution be practiced by President Donald Trump.

The threat of military conflict is yet to become as obvious as the trade war, but recent changes in US Government personnel have raised fears of fighting in Korea and/or the Middle East.

For investors, the worst aspect of what's happening is that so much depends on the moods of the people at the top of governments in each of the hotspots.

A looming oil shock?

In the Middle East, the most likely place for a war of words to become something more serious, there is the added pressure that four years of low oil prices have had on economies in the region.

Iran is the flashpoint being watched most closely, along with its archrival across the Persian Gulf, Saudi Arabia, with both sides indulging in an arms races that goes all the way up to nuclear threats backed by the potential of any conflict being a proxy war between Russia (which supports Iran) and the US (which is replenishing Saudi Arabia's stockpile of weapons).

In between Iran and Saudi Arabia is a part of the world that older investors watched with fascination, and trepidation, in the 1970s. The Persian Gulf remains a major source of seaborne oil with a critical pinch point at the Straits of Homuz which can easily be closed to shipping.

Events of 40 years ago appear to be repeating in the Middle East. That was a time of deliberate oil embargoes by members of the oil producers' cartel (OPEC), but the groundwork is still being prepared with a similar price-effecting oil shock.

Oil, thanks to the rise of non-OPEC production, is unlikely to be as severely affected by a Middle East conflict as it was in the 70s.

But, the signal being sent by both the oil and gold markets is the outlook for 2018 continues to deteriorate. Another measure of the drift towards slower growth is one of the oldest, the Baltic Dry Index (BDI), which is based on shipping costs.

The BDI tracks the cost of renting a ship to carry dry cargo, such as wheat, coal or iron ore. Since late last year, the BDI has been in steep decline. The BDI has fallen 35 per cent in three months, from a measure of around 1770 to a latest reading of 1126.

What that decline in the BDI shows is an imbalance between the number of ships seeking cargo and the available cargo – potentially an early warning sign of a decline in overall trade.

Whatever the cause of the BDI slipping lower, the index is another measure of doubt in the overall health of the global economy which, until a few weeks ago, was expected to post strong growth this year of 3.7 per cent.

If the rate of growth is slowing, then 2018, with all its political pressures, could become a less prosperous year than had previously been expected.

But it could also be a year when gold and oil shine, precisely because of what looks awfully like a case of history repeating in the Middle East, Korea and Russia. And this time, there is the added wildcard of the US shifting from a policy of America First to Fortress America – another blast from a troubled past.