While the headlines scream “War,” we will look at what truly moves the needle—and how it affects your pocket. We’ll discuss the situation, the impact on stock markets, and no less importantly, the bond markets, oil and gold prices, and what to do moving forward—each according to their own assessment of upcoming developments.
This week, economic events were once again marked by the U.S.-Israel-Gulf-Iran war. Iran, as the militarily weaker player in this event, has decided to fight an economic war. Its assessment is that high oil prices (say, above $100 for an extended period) will damage the U.S. economy through rising fuel and transport costs (which affect every product imported to the U.S.—and there are many). What works in Iran’s favor is that the impact is rapid and clearly visible to the American consumer at the gas station. The American consumer is famously sensitive to fuel prices, meaning they will notice immediately and feel the hit instantly, given their heavy reliance on private vehicles.
This cycle immediately impacts inflation—the total change in prices you pay monthly for every service and product you consume. Historically, inflation is one of the strongest factors influencing the American voter.
As we know, this is an election year for Congress, the Senate (about a third is up for reelection), and many governorships. Essentially, Iran is trying to explain to the U.S. administration, and President Trump in particular, that continuing the war will lead to a significant loss of power in the upcoming elections. This is the war equation. Since the Iranian regime’s primary goal is survival, ending the war is its first and central objective.
How does Iran intend to achieve this goal?
First, closing the Strait of Hormuz is the most effective tool. The Strait everyone is talking about is a maritime passage that, at its narrowest point, stretches only 33 km (21 miles) between Iran and Oman. There are only two shipping lanes for heavy tankers—one in, one out. Each lane is only 3.2 km (2 miles) wide, making it physically simple to block oil traffic.
What exactly is being blocked?
Oil traffic from all Gulf nations (including Iran itself), accounting for about 20% of total global movement. To understand the significance of 20% (or one-fifth) of global oil traffic, imagine that out of all the essential products you buy for your household, 20% were simply “cut.” One-fifth of what’s in your fridge, pantry, and closet simply disappears. One-fifth of the businesses you buy from are closed. Do you see the impact on daily life?
But it doesn’t end there. Liquefied Natural Gas (LNG), which serves as an oil substitute for many countries, suffers the exact same hit. Even if a country doesn’t rely on oil because it switched to LNG, it isn’t spared. And if you are an exporting country, your problem is likely even larger.
What else are they doing besides the blockage?
Striking neighboring countries to pressure the U.S. into ending the war. These neighbors lack advanced independent military capabilities—they rely on the U.S.—and have little motivation to enter a war with an immediate neighbor that can cause long-term trouble (just ask the Saudis how their endless conflict with Yemen, sustained by Iran, is going).
Europeans are also hit by the maritime blockade. Through this disruption of global energy, Iran is attempting to create a broad global coalition—ranging from the wealthy Gulf states favored by President Trump, through moderate but economically powerful European nations, down to the individual American voter.
The U.S., for its part, tries to counter this by releasing emergency oil reserves into the market to replace the “stuck” cargo. In my opinion, this is a losing battle from the start. These reserves are designed to last only a few weeks and are not a strategic solution; furthermore, they cannot fully replace the volume blocked in the Strait due to logistical constraints.
What we saw in the financial markets, and what to expect in the coming weeks:
The market is starting to “grumble.” At the start of the war, it was marketed a quick and massive success. This was reflected more in the Israeli stock market, which lives on future dreams and is willing to ignore present damage, showing gains early on. The American market, which was more skeptical and had little to gain from this war (raising the question of what the U.S. was looking for there in the first place—a story for another time), focused on the potential damage. As the days passed, oil prices rose and stock prices fell. Simultaneously, U.S. 10-year Treasury yields rose sharply from under 4% to 4.4%.
This rise in bond yields says one thing simply: “U.S., you are heading into an inflation problem soon.” This prevents the Central Bank from cutting interest rates, and you will be forced to increase government debt to fund this “fun.” As government debt grows, the interest on it continues to rise.
This situation prices in a relatively negative outlook, which some investors may see as an opportunity. Investors who believe the war will end shortly—due to the administration’s realization that future losses outweigh gains—will see a nice rebound in both stock and bond prices, alongside a drop in oil and gas.
If the administration “doesn’t take the hint” and deepens its strikes, the market will react with nervousness—not necessarily further declines. The difference? Nervousness manifests as extreme volatility. On good days, the market rises much stronger than average, and on down days, the opposite. The market stays roughly at the same levels but swings wildly like a stormy sea.
If the market believes deeper strikes will shorten the war, we return to the first scenario: Buy. If the market believes it will lead to “sinking” or “exploding” in the Iranian mud, the downward trends (stocks/bonds) and upward trends (oil/gas) will continue. Since geopolitical info isn’t transparent, the market may change its mind sharply and frequently until the picture clears.
An interesting anomaly – Gold prices, and how to explain them?
Every beginner economist knows that gold is a hedge against inflation or currency weakness. Simply put, if someone thinks a country is going into debt and its money won’t be worth much, they buy gold to maintain purchasing power. This is what happened over the last two years—the Dollar weakened (especially against gold).
We would certainly expect gold prices to rise due to the inflation expectations from the Iran war. Surprisingly, this month gold has behaved in tandem with stocks: it’s falling. Why? A few possibilities:
“Weak Hands”: Gold’s strong positive trend attracted small investors who are now selling out of fear or to realize profits alongside other assets, sitting on the sidelines. We saw a similar phenomenon in Bitcoin.
Deleveraging: American investors take loans (margin) from brokers to buy assets. When assets drop, brokers demand more collateral. It’s natural to sell a profitable, liquid holding like gold rather than a stock that crashed and is now in “prayer mode” to return to its high.
“Buy the Rumor, Sell the Fact”: A classic strategy where investors buy gold anticipating a war. The anticipation itself drives the price up, and once the event occurs, they sell because the expectation shifts toward an eventual end to the war and lower future inflation.
What are we looking at for the coming week?
Mainly facts, less declarations and commentary. An end to the fighting—for any reason—will reverse market trends, at least in the short term. Continued fighting could maintain current price levels for stocks, bonds, and gold, with high volatility or continued declines.
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See you in next week’s letter, or during the week—if I can’t restrain myself until then...