How The Iran-US Conflict Impacts ETFs

Anyone who was betting on a smooth ride for financial markets in 2020 is already questioning that view after the latest geopolitical flareup between the U.S. and Iran sent markets on a rollercoaster ride.

Stocks shed nearly 1% of their value on Jan. 3, when U.S. drones killed a top Iranian general at Baghdad International Airport. That was followed a few days later by the launching of 22 Iranian missiles into two separate Iraqi airbases that are used by American forces.

Immediately after the attack, U.S. stock futures tumbled as much as 1.7%. But then 16 hours later, during the regular trading session, stocks recovered all those losses and more, pushing the S&P 500 to record highs.

A relatively dovish response to the attacks from the Trump administration soothed tensions and at least for now, the killing of the Iranian general and the Iranian response hasn’t led to a tit-for-tat spiral of escalations that leads to all-out war.

With that worst-case scenario averted, investors were left focusing on the fundamentals that drove stocks to record heights last year—low rates, thawing trade concerns and solid economic growth.

After the close of trading on Jan. 8, the first full session of trade following the Iranian response, the S&P 500 ended with a year-to-date gain of 0.7%. Not bad, especially after last year’s 31.5% return.

Middle East ETFs Sag

While geopolitical fears haven’t manifested themselves as losses in U.S. equities, other assets have felt the impact of the U.S.-Iran conflict.

Middle East ETFs, for example, have been hit amid fears that the clash could spread into a wider conflagration of the region. The WisdomTree Middle East Dividend Fund (GULF) is down 0.6% so far this year. The fund holds large positions in stocks from Saudi Arabia and the United Araba Emirates, two regional rivals of Iran.

Year-to-date losses for the more focused iShares MSCI Saudi Arabia ETF (KSA) and iShares MSCI Qatar ETF (QAT) are even larger—2.3% apiece—reflecting investors’ worries that Iran may retaliate against those countries for being U.S. allies.

KSA Starts 2019 On A Down Note…

Interestingly, the iShares MSCI Israel ETF (EIS), up 0.9% year-to-date, hasn’t really been impacted by the conflict, even though Iran considers Israel one of its greatest regional adversaries.

It does seem likely, however, that if regional tensions are further inflamed, Middle East ETFs, including Israel ETFs, will be among those that are hardest hit.

Safe Haven Demand For Gold

As Middle East ETFs have been getting pressured by geopolitics, another group has been buoyed by the same factors. Gold ETFs, like the SPDR Gold Trust (GLD) and the iShares Gold Trust (IAU), are up 2.8% each so far this year.

Prices for the yellow metal briefly topped $1,611/oz on Wednesday, their highest level since March 2013. The reason for the rally is obvious: Investors flock to gold during times of uncertainty and the development of the U.S.-Iran conflict is as uncertain as it gets.

Close To A 7-Year High For Gold Prices…

Of course, gold was already doing quite well, even before these latest events. Prices gained 18.3% last year thanks to a U-turn in Fed policy that helped send interest rates near record lows.

It’s easy to make the case that gold would get another boost were another bout of geopolitical turmoil to hit the markets.

No Luck For Oil

For Middle East and gold ETFs, the geopolitical impact of the U.S.-Iran conflict is pretty straightforward. For another batch of ETFs, it’s not as clear cut.

On the surface, oil should be the prime beneficiary of rising tensions in a part of the world that produces a third of the world’s crude. Yet, oil prices—and the ETFs that track them—are down by 1.2% so far this year. After briefly hitting a nine-month high above $65, once the smoke cleared, oil prices dropped to less than $60 on Wednesday.

Oil Prices Struggle…

Analysts say that there is simply too much crude oil on the market for prices to rally without a supply disruption. Sure, the odds of a supply disruption may have increased, but that isn’t a reason for prices to sustainably rally. After all, prices couldn’t even sustain gains after a drone attack on Saudi oil facilities temporarily shuttered half that country’s oil output last September.

As long as the U.S. continues to pump record amounts of oil—output is currently 12.9 million barrels per day, up 1 million barrels per day from a year ago—any gains in oil futures and ETFs may be capped, barring a significant disruption to Middle East supplies. The United States Oil Fund (USO) is down 30.7% over the past five years as U.S. oil production has steadily risen.

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2