Risk markets, for the most part, ignored the threat of violence following last week’s killing of Iranian General Qasem Soleimani. Although oil and gold rose modestly during the past two trading sessions, US stocks were nearly unchanged on Monday.
Most indicative is the restraint price of risk hedges, the so-called implied volatility of options on traditional safe harbors like gold and US Treasury securities. When investors fear the worst they buy options, which entail limited downside (you can only lose what you paid for the option) and enormous upside. But the options market was unruffled by the exchange of threats between the Iranian regime and the White House.
The quiet below the surface in global derivatives markets suggests that investors assign a very small probability to a violent response on Iran’s part.
I continue to believe (as I wrote in Asia Times on January 3) that “Iran well may decide on a limited, symbolic action that fails to restore its credibility after the Sulemaini assassination. If it chooses restraint, its power in the region will diminish, and Trump’s gamble will pay off.”
If Iran attempts something dramatic, to be sure, the risk market’s present complacency will change to alarm in a heartbeat. Iran might close the Straits of Hormuz – it certainly has the means to do so for at least a few weeks – but then it would face a sustained US effort to annihilate its military.
The implied volatility on near-term oil futures rose from the mid-20% range to 30% after the Soleimani killing, while spot Brent crude rose by about 4%. As the chart shows, 30% implied volatility for oil is modest in historical comparison. When the oil price fell sharply last year, hedging by producers pushed volatility up above 50%. US oil production capacity is sensitive to prices, and any significant increase in oil prices will put marginal properties into operation and put more oil on the market. If Iran were to shut the Straits of Hormuz, the biggest losers would be Asian oil importers, and the biggest winners would be marginal shale producers in the United States.
The price of gold rose to the highest level since 2013, but other risk measures, for example, the implied volatility of options on the US 10-year note, didn’t budge. Neither did options on the Japanese yen (shown in the graph on a normalized scale), or on so-called commodity currencies like the Australian dollar and the Canadian dollar.
US oil stocks look attractive not because Iran is likely to interrupt supplies, but because the energy stocks have significantly underperformed with respect to the price of oil. The consensus of US equity analysts calls for a 20% increase in oil companies’ profits in 2020 vs. 2019, and this lagging sector of the market has a good deal of room to catch up.