The fallout from the Greek elections is having a major effect on the markets – it’s no surprise, as my colleague John Stepek notes.
However, a political shift elsewhere in the world could also have important consequences for investors. Earlier this week, a deal was reached between the two main Israeli political parties, Likud and Kadima. This could signal a major development in the Israel/Iran situation.
Iran remains a threat
For the past few months we’ve been keeping an eye on the threat posed by Iran’s plans for nuclear development. As we’ve said before, the one thing that unites most of the Middle East is a desire to stop Tehran getting nuclear weapons. Given that sanctions are not working, the only way to stop Iran seems to be an Israeli and/or US airstrike.
However, the US fears that a strike – quite apart from risking war in the Middle East – could lead Iran to try to shut down the Strait of Hormuz, sending the oil price sky-high.
Because of this, it has been pushing hard for a deal. Under one solution, the US would agree to drop all sanctions provided Iran promises not to enrich uranium above 20% (90% purity is needed for a bomb).
The trouble is that it is very easy to increase purity from 20% to 90%. In any case, Tehran has rejected similar deals in the past.
This presents a problem for Israel. At best, a nuclear-armed Iran would increase Tehran’s ability to ramp up support for terrorist groups. At worst it could directly threaten Israel’s existence.
However, Tel Aviv knows that the US doesn’t want it to take action. As we’ve said before, while the US would not directly punish Israel, it could do a lot of harm by simply standing aside. Iran has also been taking counter-measures to shield its reactors and centrifuges from an attack.
This has led many in the Israeli military and intelligence services to argue – in some cases publicly – that the risks are too high. While Israeli prime minister Binyamin Netanyahu has repeatedly talked about action, this opposition has won the day – until now.
Netanyahu’s gamble
In a move that has taken many by surprise, the Israeli PM has formed a coalition with the main opposition Kadima party. This increases Likud’s majority in the Knesset (Israeli parliament) and means that Kadima’s leader, Shaul Mofaz, becomes Deputy Prime Minister.
While this deal will affect many issues, the one with most international relevance is that it could recast the debate over military action.
While Mofaz does not think now is the best time to act, he agrees that a strike will have to happen at some point. He has also said that he would change his mind if new information emerged. Having him in the cabinet would make it much easier for Netanyahu to convince him.
If Netanyahu pulls it off, it would strengthen his position greatly. Having a former army chief by his side would make it much harder for military critics to pull rank on him. It would mean that the two largest parties were behind any attack.
Even if the PM failed, it would be harder for Mofaz to speak out against it. As everyone knows, it’s better to have someone in your tent, spitting out, than to have him or her outside spitting in.
We’re not the only ones saying this. The Jerusalem Post notes that “by inserting Shaul Mofaz and Kadima into the government, Prime Minister Binyamin Netanyahu might be trying to close the ranks ahead of… a war against Iran”.
How to protect yourself
We’re not saying that a strike on Iran is a certainty by any means. However, there’s a more than outside chance of it happening – Israel may not feel it has any choice, since time is running out and a nuclear-armed Iran would be too risky for it to accept. So it’s worth considering how this would affect your portfolio.
An Iran-related spike in oil prices could hit world growth while pushing up inflation. This would hit both shares and bonds. However, as we noted before, oil may not be the best hedge. Experience shows that a rapid increase in oil prices can be followed by an equally sharp fall. This is because reduced economic growth will hit consumption.
Meanwhile, in the US, natural gas has the potential to fill any gaps in supply. And if there isn’t a strike on Iran, the current fears over global growth could cause prices to fall. Already WTI crude is below $100 amid the European crisis, and Capital Economics thinks that Brent will follow suit.
Therefore we are sticking with gold. Not only does it hedge against a wide range of political risks, it will benefit if any of the major world central banks begin another round of quantitative easing – which they may have to, particularly if an oil price spike hits the global economy.