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One to Watch! The Middle East and the price of Gold

One to Watch! The Middle East and the price of Gold

Dear Reader

We hope you have had a good New Year's Celebration and are looking forward to getting back into the routine after the holiday season.
 
One thing I find fascinating about research writing for Bleyer is that so many threads of geo-politics are connected.  It is like a house of cards, each card intrinsically supporting or weighting on to another. But it isn't actually always that simple.  I sometimes find I'm stumped to see a connection between two events, until suddenly one appears.  At other times, one line of information actually contradicts another and I wonder how such a house of cards could have been built so illogically, and clumsily, in the first place.
 
For example, the other day I became so perplexed by whom is fighting whom in the Middle East that I scribbled down a flow chart while reading the news, like you do!  And I came to the obvious conclusion, after some research, that the U.S. administration is backing both Turkey and the Kurds, who are - by sheer contradiction of logic - fighting each other!  That kind of U.S. foreign policy just doesn't make sense.  Then there are the Gulf States, who are Sunni-led and but then there is ISIS, which is also "Sunni" in the sense that they are killing any Shi'ite they can get their hands on, as well as Yazidis, Christians and Jews. But the Gulf States and ISIS are also enemies, obviously.  It's an insane boiling pot.  
 
"Gold prices spiked higher on Monday, amid mounting geopolitical tensions in the Middle East after Saudi Arabia cut diplomatic ties with Iran over the weekend.... Also on the Comex, Silver futures for March delivery inched up 1.17%" (CNBC Money Control, 4th January 2016)
 
And while keeping up to date on reading the financial news over the holidays, I came across another classic example of the strangeness of the global situation in which we are currently living and the contradictions it holds. Firstly, I smiled and made a record of an article published on 30th December entitled, "The world's political and economic order is stronger than it looks."  With a headline like that, what could possibly go wrong?!  As author exudes, "The fateful rupture between the US and China that many feared has not in fact happened. Washington has so far managed the rise of a rival superpower more or less benignly. China has just been admitted into the governing elite of the Bretton Woods financial system with the backing of the US Treasury."  
 
Then fast forward just 5 days later to 4th January 2016 and the same broadsheet announces; "FTSE suffers worst stock market start in 16 years as China-led malaise wipes £38bn off index."  "Trading floors began the new year in a state of chaos as weak economic data from China and heightened tension in the Middle East wreaked havoc on financial markets worldwide. Britain’s benchmark index suffered its worst new year start in 16 years. The last time the FTSE 100 made such a bad start to the year was on January 4, 2000, when it sank 3.81pc - its worst new year start in the FTSE 100's 31-year history."
 
You couldn't make it up; such extreme dichotomies! So, what is the truth?  Do we act to prepare or do we just sit back and relax?  Sometimes your guess is as good as mine!  Having said that, I've been talking for some time about China and its aspirations of ending the dollar as the world reserve currency (Bleyer Blog, August 2015) And I've also been saying in the Bleyer Blogs for some weeks now that I believe 2016 is going to be a very bumpy ride.  So let's now examine the last of those three points raised by the Telegraph, the Middle East.
 
This last week, tensions in the Middle East are the one headline that has grabbed my attention in that troubles have risen very fast, and so the situation could be one to watch, as we once again share our weekly blogs on events which could affect the price and demand for physical Gold and Silver bars and coins.
 
The Growing Tension in the Middle East:
 
The Middle East is one region I find particularly facsinating.  I believe essentially that the reason for the wars in the Middle East are very simple to identify, but very difficult, even humanly impossible, to solve. Ancient and timeless, yet modern and influential, this region of politics and ideologies is hard to grasp for the modern European. This is clear by reading about 95% of commentaries written by 20-something post-modernists in the Western tabloids.  The European perspective is often lacking in depth or regional nuance.  I say that as a learner myself.
 
So, this week's explosion of tension between Sunni led Saudi Arabia and Shiiite led Iran is one to watch closely:
 
"In January 2014, Douglas Murray explained in The Spectator how relations in the Middle East were becoming increasingly tense. With Saudi Arabia having now cut diplomatic relations with Iran, Douglas’s insight seems prescient. The Middle East is not simply falling apart. It is taking a different shape, along very clear lines — far older ones than those the western powers rudely imposed on the region nearly a century ago. Across the whole continent those borders are in the process of cracking and breaking. But while that happens the region’s two most ambitious centres of power — the house of Saudi and the Ayatollahs in Iran — find themselves fighting each other not just for influence, but even perhaps, for survival. The way in which what is going on in the Middle East has become a religious war has long been obvious."
 
But, to the average reader in Britain, we want to know how does this affect the U.K. foreign policy?
 
For the UK and other lesser western powers, declining involvement in the region is neither a moral nor an interest-based decision. It is simply a decision based on the fact — as the last decade has proved — that we no longer have either the cash or the commitment to effect any decent outcome in the region....To an extent, what is happening in the Middle East is what happens when America and the West suddenly lose interest."
 
So, back to my flow diagram of the region;  Russia, Iran (Shiite), Hezbollah and Syria (President Assad) have formed a coalition on the one side, while on the other side there are the Gulf States (Sunni) of Saudi Arabia, Qatar, with Bahrain and Sudan also breaking off Diplomatic ties with Iran.  
 
The opposing sides of these forming coalitions (Saudi Arabia vs. Iran) recently backed different sides in the civil war in Yemen, with Saudi Arabia trying to back a coalition government after years of a North/South divide, while Iran is backing the anti-government rebels (the Houthis.)
 
In Iraq there are Sunnis and Shiites fighting each other.
 
In Syria, on the one hand the U.S. administration supports the Syrian Islamist Opposition Rebels and on the other side Russia, Iran and the Syrian President Assad form the opposing coalition. 
 
Most states are fighting ISIS, including the Kurds, who are also backed by the U.S. administration.  However, the Kurds are also fighting Turkey, who is fighting Russia. But Turkey is also backed the U.S! So, in essence, two of Washington's "allies" (The Kurds and Turkey) are fighting each other!
 
You can see the need for a flow chart! Confused?!  Although Islamic terror is getting the headlines, the one I would most closely watch is not actually ISIS, as horrific as such a barbaric group's acts often are.  I would actually be watching Putin behind the scenes. The rowsing Russian bear has not become involved in Syria for altruistic reasons, of that I believe is certain.  Putin is winning somewhat of a media war at the present time, and may for some time to come, in that he is "bombing" ISIS.  But he is also bombing the anti-Assad rebels and the question must be asked, "Why is he investing Russian war planes, troops and money into Syria?"   And, incidentally, the main beneficiary of arms trades in the region will be China, as well as the opposing current super-powers of America vs. Russia on both sides of the opposing coalitions.
 
But one tiny point caught my attention, because it is a supporting joint in this increasingly tumultuous house of cards. And that is oil and the petro dollar.  For decades the world's oil has been traded in dollars and therefore is pegged to the dollar's worth.  For some time, Saudi Arabia has been flooding the market with cheap oil to drive competitors out of business, One of these competitors is Russia.   
 
"But now it is getting more and more difficult.  The oil war Saudi Arabia has waged in the oil global market may have negative consequences for the Saudi economy, American author and journalist Matt O’Brien wrote. The reason is that while oil incomes are falling Riyadh is about to make the same mistake that Europe has over and over again, the author underscored. This is cutting its budget without lowering interest rates or softening the economic blow.  The key problem is that the Saudi riyal is pegged to the dollar which forces the kingdom to raise interest rates when the US Federal Reserve does. The result is that Saudi Arabia’s currency has gone up against almost every other currency at the same time its economy needs it to lower it. When oil prices rise the national currency should be devaluated, the author noted.  Other oil-dependent countries like Azerbaijan and Kazakhstan have already given up their dollar pegs. This is why markets are beginning to bet that Saudi Arabia will be next. You can only defy economic gravity for so long."
 
 
And that is what is so key.  The unpegging of the dollar as the unit of currency in which most of the world buys its oil will help China, which helps Russian, which helps Iran, which helps all the "enemy" states of Saudi Arabia, which ironically thought that selling it's own oil cheaply would get rid of the competition, not help it. Like I said, it is a house of cards clumsily built; because global human ambitions usually are clumsy and they often backfire. The oil move by Saudi Arabia is like accidentally scoring an own-goal.  But that could equally be said for the U.S. Administrations Middle Eastern foreign policy also.

War in the Middle East is never good.  Firstly because it is war and innocent people suffer. Secondly, because it's a match most often played out by regional players but with Russia and America as the managers of the opposing teams. I can't stress this enough.  When we read of Middle East turmoil, I recommend reading how each side benefits or detracts from the two opposing super powers.  From Reagan's era through to about five years ago, the Russian bear looked as if it has just laid down and gone to sleep. But it hadn't and is now wide awake. While most of the press focus on an insane tribe with a black flag called ISIS, the major players of Russia and China are gearing up behind the scenes. Keep an eye on the energy dependency of the nations in the region.  I briefly mentioned a few months ago that a very large oil field was discovered in the Golan in Israel. If this oil find threatens to undermine the oil-dependence in the region, I would not be surprised if Israel finds herself under the increasing envious eye of Russia and their Middle Eastern coalition.  And thirdly war in the Middle East is never good because the price of an oil war affects us all.  Now, this may seem ironic at a time when petrol has dropped to below £1 per litre at most U.K. supermarkets.  But this is precisely due to an oil war; a war to price out the competitors. And what happens when all the competitors are gone?  The price rockets. At some point, the house of cards will collapse and the artificially low oil price will rapidly rise.  The need for oil from Western nations has shaped the questionable morals of historic decisions in the region for decades and I would shake my head in happy amazement if that were about to change anytime soon.

So, here is the crux of the matter. Just as we have seen this week, increased turmoil in the Middle East tends to increase the price and demand of Gold and Silver. In addition, oil price affects the price of petrol, food production, food transport, heating, plastics production, the list goes on. Once it springs back, the safe havens of Gold and Silver may well be rapidly unattainable.  Knock out the other table leg of the petro-dollar and have countries trading oil in a currency other than the dollar and you have the collapse of the only super-power we in the West have ever really known.

It is tempting to gloss over Middle East headlines and think, "They're always fighting each other so how can we keep up with who's fighting whom?" But it is too great a layer of the house of oil and currency cards to ignore.  

In conclusion, written way back in 2011, the following extract by Julian Phillips is even more applicable today when he writes, "Do not be surprised to see major levels of speculation rise in the oil market in expectation of the worst.  In the past the gold followed by the silver price has only been indirectly influenced by the oil price. The uncertainty that the oil situation posed to the global economy had a direct impact on the two precious metals. The recession and credit-crunch followed, pulling all markets down and causing a 20% + correction in the gold and silver prices. But this time, we would expect to see far less of a reaction in the precious metals should the worst happen. After all, the precious metal markets have continued their uptrend, despite these crises. In fact it is these crises that have prompted more accumulation of the precious metals while other markets have stalled.   This time investors have tasted the bad times before, so will not react as precipitously as they did then. We feel they will turn to precious metals quickly, from other markets. After all, the potential of these situations points to extreme times in which precious metals come into their own." (Financial Sense)

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