Words on Tensions in the Middle East (Part 2)

In this episode of Words on Wealth, host David Hay is joined by CIO Tim Rocks for an update on the evolving situation in the Middle East and what the latest developments mean for investors. They discuss why the impact on oil markets has been larger than expected, the new scenarios now in play for oil prices, and what the broader macro effects could mean for the global economy. With equity markets down, they also explore whether this represents a buying opportunity, and what key signals to watch in the weeks ahead. Tune in to find out more.

This episode is also available on Apple Podcast. 

Here is the edited transcript:

David Hay Thank you for joining us for our live recording of our Words on Wealth podcast. And obviously our webinar today, the podcast will be released as it normally is tomorrow. My name’s David Hayes, Senior Investment Advisor at Evans & Partners. I’m joined by our Chief Investment Officer, Tim Rocks. Tim, welcome.

Tim Rocks Thank you David and good morning to all.

David Hay We thought it was important to follow up last week’s webinar and Words on Wealth podcast with the topic, oil getting slicker for markets. We’re certainly not going to provide weekly commentary, but we thought it important to be in front of clients. And we’re certainly not making light of any of the human impact of any of the conflict that has happened in the Middle East, frankly, over the last two years or longer.

So we thought we’d follow up and get an update from Tim Rocks. Now we’ve had some questions that have been sent in today. We’ll address those. There is also the opportunity on the call to lodge a question in the questions bar at the bottom of your screen. So please feel free as we chat to ask us some questions. So Tim, let’s kick it off. ⁓ What has changed with your views over the last week since we were in front of clients previously? And from a market perspective, is oil the key issue here?

Tim Rocks Well, it certainly is. But the big picture view has not changed, which is that this is not going to be a 1970s style oil shock. We’re not going to have a global recession. Oil just simply doesn’t matter as much now as it did in the 1980s. And the sources of oil supply are so different to what it was back then. So that hasn’t changed.

What has changed, I think, is that the prospects of a very quick resolution have faded. And that is because Iran clearly sees its main method of attack to disrupt oil. And it’s doing that, for the Australian four-muse. And also the new Iranian leader is perhaps the worst case scenario for Trump and for a quick resolution. So I think you have seen more equity market volatility this week.

And that’s probably because markets were initially too optimistic about how quickly things would be resolved. So they’ve had to adjust for that. But yeah, overall big picture, we’re still seeing this as a period, as something that might result in a few weeks to a month of volatility, but no fundamental change to the trajectory of economies and markets over the course of the year.

David Hay Yeah. So Tim, that volatility we’ve seen is that investors sort of forecasting out potentially oil shocks and other things around global growth. And therefore, you you get those movements we saw last Friday, pretty big move. Is it that extending, I suppose, of the conflict and the broader impacts on the globe?

Tim Rocks I mean, I think a lot of it is just simply uncertainty. Investors don’t like uncertainty. Big institutional investors tend to reduce all of their bets when there is uncertainty. So I think it’s more correct to describe this as volatility, as more than a big sort of change in sort of in market views, I would say. I mean, the big question, of course, is whether this causes a global recession.

or something close to it or something approaching that. And really on that, we’re still where we were, where I thought we were a week ago, which is that it’s very, very unlikely, I think. I mean, a lot of these sort of global economic think tanks have run the numbers. And even if the oil price goes up to $100 and stays there for a few months, you’re still only talking about 0.2 % of global GDP. Now that’s not nothing.

⁓ But it’s certainly not a really significant deal and there are always policy offsets that is likely that the US will deliver a lot of fiscal stimulus. know, they have to rebuild their war stockpile or have to pay off some farmers, probably pay off some motorists. You might see some additional stimulus in China. So all of those things tell us again that it’s just really, really unlikely.

that where this is going to cause a meaningful dent to the global economy.

David Hay Yep. So you’ve sort of partly answered it Tim, but you know, the scenarios from here, from your point of view and your flag abroad, your view remains essentially unchanged from a week ago. A week’s not a long time, but where to from here?

Tim Rocks Yeah, so for the oil price, think the best, the most likely case now would be that oil stays around that $90 a barrel level for weeks or maybe a couple of months. So you’d now give that say an 80 % probability. What the better outcomes, which is a quick truth, you give a really rapid return to $60 or something.

You’d have to take that off the table because that would only occur if there’s actual truce with Iran and that seems unlikely. But I’d also say the really bare case scenario of $150 would occur only if there was a major damage to energy infrastructure in Iran and the rest of the Gulf. And it’s been actually quite noticeable, perhaps. It’s really, really clear that they don’t want to do there.

do that. US doesn’t want to do it. Iran doesn’t want to do it. So the fact that energy infrastructure has stayed intact for now is quite encouraging that you’re not going to get a much worse outcome for oil.

David Hay tilled but staying in the same infrastructure. Gas is interesting. We talked about that last week. Is that still the case?

Tim Rocks Yeah, it is. mean, everyone all the focus is on gas. I’m sorry on oil, but but not on gas. Important to remember that Australia is the world’s second largest gas producer. And these changes will directly affect the Aussie companies, not so much in a volume perspective, because the volumes are locked in. But they have pricing that is a direct function of the oil price. So within a few months,

they will start receiving a higher price because the price on those six-turn contracts is a direct function of the oil price. So that is good for them ⁓ over time.

David Hay Some other parts in the Middle East have been dragged into this, probably the UAE is the one that sparks my mind. Is there impact there more broadly or is it sort of contained in those regions? You think about Dubai as a tourist hub, an airport hub, is there some other thinking around that?

Tim Rocks Yeah, so that’s a good point. So even though globally I mentioned that it’s just very, very hard to get to see a really big impact, there are certainly some regions that are going to be more affected by others. For Dubai, Qatar, Bahrain, this is a pretty big deal. Those economies are heavily dependent on tourism, on the airport stopover thing, on expats.

wanting to live there. And all of those have been significantly brought into question. So that’s point one. Point two, Europe is more affected through natural gas prices. Remember, this will be the second big gas crisis in Europe after Russia, Ukraine. And when they lost Russian gas, they decided to start buying a lot more on spot prices from the Middle East. And spot prices, of course, gone through the roof.

So Europe is a little bit more affected here. You’d also say emerging markets at the margin a little bit more affected because they are also big importers. At the other end, US is kind of okay. US is less affected, one, because it’s self-sufficient in oil, but also because the currency’s gone up. So when you’re thinking about the impact of oil prices, you’ve got to add in the currency effect too. So the oil price has gone up. So ironically, US, well, perhaps it’s not ironic, but US won’t be

⁓ as affected by this as some of those other regions. But again, we’re still only talking about percentage points off growth and not recessions.

David Hay You make an interesting point about the repatriation potentially of some expats back into their home countries that could have a knock on effect. We’ll talk about that maybe in the future. You’ve alluded to this a bit, Tim, central banks. So have they got the firepower that’s needed if there is a knock on and effect on global growth, the conflict goes on longer. Have they got the firepower and what do they do?

Tim Rocks Yeah, well, actually the RBA is in fact the most interesting central bank globally. So Australia is a bit different because we already had a small inflation problem and the RBA was already on a hiking path. So there’s much less scope for them to relax about further inflation pressure. So they’ve got a meeting next week and the RBA deputy come

Governor in fact has been out in the last couple of days, just hinting that they may well increase interest rates next week. So most people thought they were going to do two rate hikes this year anyway, and were thinking that it was May, but they may well bring that forward to March, and they may well have to do one or two more than they were expecting. In terms of the other central banks that were like, the Federal Reserve in the US is on a rate

cutting path, it might delay its rate cut plans, but again, that’s sort of at the margin. So anyways, would be very interesting to watch RBA next week.

David Hay How about the European region, Tim? I think you mentioned last week that Europe could be impacted ⁓ more by this conflict. Do they have the firepower as well if they need to reduce rates?

Tim Rocks The problem is in Europe, rates are already pretty low. So they’re about 2 % in Europe. ⁓ I think they’d be more, Europe doesn’t have an inflation problem. ⁓ So the ECB would be more comfortable in seeing through any inflation pressure. But the fact that the rates are already low ⁓ just does limit their power to do so.

David Hay So stimulus is required in that region, they might have to use other tools.

Tim Rocks Yeah, and I think that there’s some prospect here that they will accelerate the fiscal stimulus and rebuilding of weaponry and defence that was already in the pipeline.

David Hay I’ll put my store person hat on Tim. I’m an investor. Markets are down. Is there an opportunity here and where would you look?

Tim Rocks Yeah, look, I mean, I think so. mean, perhaps sort of stepping back and, you know, our main message on dealing with his volatility is it’s okay to do nothing while the volatility is playing out. If you’ve got a well diversified portfolio with some say alternative assets like gold that are sort of, you know, less correlated with big macro events, you know, you’re going to be well set up to deal

with this sort of volatility. So our mindset then is to think, well, if markets overreact to this, ⁓ that it may well be an opportunity ⁓ to increase exposure to those assets that fall too much. I think we are pretty close to that now in Australia. The Aussie market’s down about 5 % since the peak, ⁓ at a time when actually the fundamentals for the Aussie economy are improving.

So ⁓ yeah, so in some of our portfolios, we actually did increase some exposure of the Aussie market during the week. I think the sector that’s most interesting is resources, big cap resources have been hurt ⁓ by association. The stream of logic seems to have been, China might be really affected here. And if China is affected, then iron ore and the resource companies will be affected. So they just got sold down. ⁓

by that stream of logic. I think that’s overdone, totally overdone. We don’t think this is bad, too bad for China. And there are plenty of other compelling structural reasons to like the resources now. So anyway, yeah, so generally, yes, there are now opportunities for investors from this and there’s some of the places they should look.

David Hay And how about internationally, Tim, is it the same sort of view?

Tim Rocks Yeah, pretty much. I think that the area that is being really affected in terms of regions is actually in Asia. ⁓ And again, you can understand the logic. China, Korea and Japan are all massive, massive oil importers. ⁓ So and predominantly from the Middle East. So they are kind of vulnerable here.

But again, the same logic, if you really don’t think that the oil price will stay long for too long, and there is other potential policy responses that will mitigate those risks, then you’re just simply looking at markets that have fallen and could bounce back pretty quickly.

David Hay There are bond issuances that happen every day. I know some of those bond issuances, they feel like the rates on offer are perhaps a little bit higher. Is there an opportunity there either on the fixed or the variable side, Tim, to look at if that’s part of your investment mix to look at those?

Tim Rocks Yeah, absolutely. So actually, another really surprising thing is that Australian government bond yields have been affected by this. So the yield has increased. They actually briefly touched on 5 % a couple of days ago. I think that that is interesting. So there might be an opportunity here, some combination of higher inflation and RBA hiking rates a bit more quickly that Australian government bonds actually start to look interesting. I mean, if you can lock in a 10 year rate.

⁓ above 5%, that’s pretty good. So then there could easily be opportunities in some of those other asset classes too.

David Hay And my final more specific one, gold. We know the run it’s had over probably the past 18 months, two years. I’ve heard some compelling arguments wide ⁓ separate to what’s going on in the globe from a conflict point of view that the outlook is still strong. Do you have a view on is it too late to include that in the portfolio? And is these issues that are going on a reason to reconsider it?

Tim Rocks Yes is the short answer. We think gold makes a lot of sense in portfolios now. It’s actually surprising the gold price hasn’t reacted very much in the last few weeks. And maybe that’s just a reflection of the fact that it had gone up so much in the last year. But there’s a lot of structural reasons why gold is going up. It’s all concerns about US dollar, US debt, central banks globally, switching their reserves out of US bonds and into gold.

⁓ And that if they’ve started that, that could go on for a long, long time. So yeah, gold makes sense in portfolios because it’s that uncorrelated asset kind of argument. But also I think there’s a lot of compelling structural reasons that will support the gold price in the medium term.

David Hay We might go to some questions. We’ve had some that have been sent in. I’m actually going to go to one quickly off the chat. So thank you to Anonymous for sending this one in. Putting aside the oil price shock, ⁓ what are the risks to suppliers of fertilizers, other fuels, et cetera, ⁓ and the shortages, the stripe of the moose, which is potentially being blockaded? Is there other knock-on effects for other non-oil or gas commodities?

Tim Rocks Yeah, so that’s a good question. So everyone focuses on oil there, because it’s 20 odd percent of oil goes through the stratiform ooze. But there are definitely others that are affected. Gas is one of them as well. So that’s 20 odd percent. And fertiliser is another big one as well. So there’s the potential for shortages to occur there.

You’re probably going to see actually some policy response on that. So Trump has already talked about giving subsidies to farmers to support those increasing fertilizer prices. And there’s also a range of other, you know, sort of smaller commodities that get affected. And actually, so one of the really interesting medium terms of stories here is that it’s highlighted the risks around supply for some of these other critical minerals, not just oil. So at the moment, everyone’s fixed, you know,

everyone already has big strategic reserves of oil, but we could be in a situation now where China and India think about having much bigger strategic reserves of a broad range of other commodities. And as they build those reserves, it could support prices for another sort of year or so. And that’s one of the reasons actually, think this is, resources really stand out here. If China decides to build a much, much bigger reserve of copper or iron ore or something just to protect itself, then that’s actually pretty interesting.

David Hay Yeah, going back to the COVID, isn’t Tim about supply change and can we do what we need to do in everyday life?

Tim Rocks Yeah, so and actually, so that’s that’s the point I meant to make like the when you’re talking about oil, it’s not so much the price increase that causes a recession. It’s actually the inability to get any supply. And the way the world’s changed over that 30, 40 years where there’s these such big strategic reserves and there’s there’s you ⁓ know, there’s there’s more supplies around.

just really, really mitigates that fact. Because if you went back to the 1970s where you did have recessions, the issue then wasn’t the increase in price, it was the fact that there was just simply no supply, there were queues for gasoline and stuff. And that’s one of the things that’s really, really different this time.

David Hay The fertiliser one is interesting too, Tim. Farmers don’t produce as much food or it’s more expensive. Supermarkets have passed on into our pocket as well. So there’s another one as well. You mentioned China there before. If they had to permanently buy oil at higher prices on the open market, would that have an impact on their economy? Albeit you’ve highlighted very plainly that they have a big reserve at the moment.

Tim Rocks Yeah, so the reserve thing’s interesting, but it’s important to recognise how ahead of the curve that China has been on this sort of energy security front. So they have 30 % of their electricity generation already comes from renewables. 50 % of their cars are electric. They have been increasing the amount of supply coming from Russia and Saudi recently. So China has definitely been on the front foot here.

So I think China is not as vulnerable as people think, ⁓ know, point one, but point two, I think there’s also has other policy measures that it will enact in the short term if there is a hit to the economy.

David Hay Reminding you, these are questions from clients, so it’s good to be able to pose them to Tim on your behalf. The Aussie dollar, what does this all mean for the Aussie dollar, Tim?

Tim Rocks Aussie’s actually been one of the real surprises ⁓ because ⁓ conventional wisdom and what I would have thought is any kind of event like this is Aussie dollar gets punished. You your first thought is, there’s some kind of crisis on Aussie dollar that will go down 5%. So that hasn’t happened this time around. ⁓ I can’t really… ⁓

not clear why. Perhaps it’s because the the expectations for the RBA to raise rates. Perhaps it’s because people are seeing through some of those consequences for other commodities. It’s not clear why but anyway Aussie’s been a been a bit of a surprise here.

David Hay In the case to maybe look at hedging in portfolios, if it hasn’t happened, then it’s a bit of a surprise. I’m not saying it will happen, but.

Tim Rocks Yeah, well, yeah, I mean, our kind of medium term view, shall we say that really hasn’t been changed by all of this is the Aussie is going to keep going higher. ⁓ So, you know, somewhere towards 80 cents over the next 12 months or so. So it’s definitely a good time to make sure that the hedging in your portfolio is right. Otherwise that rise in the dollar will really hit.

holdings of international shares that you’ve got.

David Hay Yep. Another question. Under the Alternatives bucket, are there risks for private credit? We’ve already touched on the equity market side.

Tim Rocks ⁓ Yeah, so the alternative question is really, really interesting because a lot of clients have ⁓ private equity, private credit that they didn’t have 10 years ago. So it’s important to think about how they might be affected. ⁓ I would say the direct effects are probably pretty small. ⁓ Private equity and private credit don’t tend to buy

the companies in the industries that are most directly affected here. They’re not gonna be investing or lending to airlines or transport, so type companies or even tourism companies. So there’s no direct effects. ⁓ But there might be indirect effects if this is a really long run story. And some of those effects might be for private equity.

The private equity model relies on you buy a company and then you sell it three years later. If you can’t sell that three years later because equity markets stay volatile, then that pushes out ⁓ when you get your returns. be wary of that, but that really only happens if things get a lot worse. For private credit, I would say what’s going on with the software companies and concerns about that is a much bigger issue than.

than the oil price, I think. And we do, again, if this gets a lot worse, there may well be more of those liquidity challenges in the sector. then what happens when companies do that is they gate returns. So you can’t get your money back for a quarter more or a year longer. I mean, again, I don’t think it’s anywhere near enough to worry about that now, but they might be some of the indirect effects.

David Hay I might combine two questions here, Tim, probably we’re circling back to oil as a continued question, but it’s great that people are posing these questions to us. Are there specific sectors which you see sort of more affected by their oil price? And I suppose in the same breath, ⁓ we import a lot of oil in Australia. Do we get that from the Middle East or are there other sources that we could get it from?

Tim Rocks ⁓ Yeah, so, okay, yeah, so good question. So, let’s talk about companies that are affected most. So any company that either uses a lot of oil as an input or very directly is gonna be more affected. And the obvious one there is the airlines, Qantas and Virgin. But they’re actually pretty interesting, right? Both of those companies have hedging policies of about 80 % of their oil is hedged.

for up to two years. So the interesting thing now for these companies is they are starting to increase prices. Qantas has already supposedly started to increase prices, but their costs won’t go up for a year or two. ⁓ So this is good old fashioned. Well, should we call it profiteering? I don’t know. I don’t want to get in trouble, but ⁓ yeah, this is kind of one of those interesting things. So it’s the dynamic between the hedging program and…

and what’s going on in the market. But anyway, the transport companies are the obvious one to look at. I mean, if things got really extended, then you start to think of what it might mean for consumer names too. So where the consumer is actually sort of cut back on spending might be a risk if this got a lot, lot worse, but I don’t think we’re there yet.

David Hay Australia where do we go.

Tim Rocks And the second part of that, yeah, yeah, so yeah, Australia is at a national level, it does feel as though we’re a bit vulnerable here. So ⁓ all our oil or the vast majority of our oil does come indirectly from the Middle East. The added complication here is we don’t even refine oil anymore here. So the petrol that comes into our cars comes oil from the Middle East to Korea, Japan, where it gets refined and then sent on to us.

So there is definitely a vulnerability there that any part of that supply chain ⁓ could come under pressure. And we actually have fewer reserves than we should. We’ve only got 30 days of reserves. So there is the risk that the petrol price in Australia is hit a little bit more than others. And that’s probably one of the things that’s in the RBA’s mind.

David Hay Two final questions, Tim. I’ll ask them separately. So we’re in front of clients, all of you today, because we want to communicate our views and keep you as abreast of our thoughts as possible. But Tim, from the Evans & Partners strategy team, how long if this conflict or oil or any of the topics we’ve talked about today goes on for? How long before you recast your views or revisit asset allocation? I know it’s a daily thing normally. Does any of that change currently?

Tim Rocks Well, as I mentioned, we did actually change our asset allocation during the week. So the day when the market was down 4%, we decided to actually increase some equity exposure. So that, I think there’s two aspects to that question. Number one, how do we respond to market developments? And the short answer is, I think you should if markets overreact.

The broader question perhaps is one, is do we really need to rethink our three to five year view on assortation based on the fact that we could be in a slightly different world ⁓ of more geopolitical risk? ⁓ And that’s a fair question to ask too. ⁓ I think the broad answer to that question is that we should make sure that we have well diversified portfolios.

And if we don’t, think ⁓ there’ll be an opportunity for investors to do that, but probably best to do that when markets are calm rather than when they’re choppy. So I think over the next few months, we’ll start to talk a lot more about ways to diversify and important for investors that haven’t really explored it, that there are a lot more opportunities now in that alternative asset space. Obviously we need to be careful.

of some of those risks I talked about before. But another one might be investments in infrastructure, for example. Infrastructure is quite a nice ⁓ asset class in these types of scenarios. Tends to have inbuilt price protection ⁓ and actually volumes that might even be linked to oil prices and the like. So yes, some things do in the short term, but also a good kind of note for you to bring up with your advisor at your next meeting just to make sure that you’re

you’re fully positioned for, I guess, period that might be more, more of these things might occur.

David Hay One final one, Tim, not necessarily the most pressing one, but obviously there’s a summit later this month with Trump and Xi, China and the US. Is that, do the stakes, have they risen here? Is there any impact on that? ⁓ Or is that a date where Trump might want this all wound up?

Tim Rocks Yeah, I think your final comment is the one there. I think he’ll want to go to China showing that this is all done and over because it has put China in a difficult situation because I think 10 % of the oil did come from Iran. I don’t think it’s an existential threat, but it has been a challenge for them. ⁓

It would be a much more awkward conversation if that’s still going on and China still had concerns about those things.

David Hay Thanks Tim, think we’ll leave it there. Great insight. Thanks for your thoughts. Thanks for everything you’re doing and communicating through both to clients and through the advisor network to go to clients. So thank you.

Tim Rocks Yeah, my pleasure and just a note to clients. If there any questions we didn’t get to because we did have a lot, please highlight them to your advisor and we can get back to you directly.

David Hay Very good. And thanks for the questions that have been posed ahead and in lifetime. We won’t commit to be back next week exactly in this forum, but what we will commit is to email you back when as things evolve and when we need to update you in real time. Just a reminder that everything we’ve discussed today is considered general advice. For those after personalised advice, you’ll need to reach out to your advisor. Thank you everyone. Stay safe.