Simit Patel

The combat currently going on in Gaza involving Israel and Hamas could have profound effects on the financial markets. Let's take a look at the situation.

Where We Currently Stand

Egypt and France are leading the way to broker a truce between Israel and Hamas. Egypt's ambassador to the UN, Mr. Maged Abdelaziz said peace talks could begin in Cairo today (January 8, 2009). French President Nicolas Sarkozy has said Israel has accepted the ceasefire plan. And in what could be a step towards a peace agreement of sorts, Israel halted its military operations for three hours yesterday to allow for civilian aid; Hamas is reported to hold fire during those hours as well. The Scotsman has a more detailed report.

Still, though, the conflict has widened, as rockets from Lebanon have struck northern Israel today. Bloomberg has the full story.

Ultimately, the geopolitical scenario remains tense. If the conflict continues and widens, it sets the stage for a larger war to emerge, with US, India, and Israel on one side, and Pakistan, China, and Iran on the other. Economic interdependencies can help expand the war as well, and may have the impact of pulling in seemingly uninvolved countries, like Russia and Venezuela.

Impact on the Financial Markets

Four key observations:

1. As bad news and uncertainty in general tends to be bullish for gold, this could stimulate demand for gold. We have already seen a bit of this.

2. Given the economic aid US provides to Israel, the threat of economic warfare against the United States becomes more likely as a way of weakening Israel. Economic warfare would come in the form of selling US dollars and US Treasury bonds. A key turning point to watch for is if China is pulled into this conflict, as China is a large holder of US Treasury bonds and thus more capable of waging economic warfare by dumping Treasury bonds. Thus far, China has urged for a ceasefire, though China has been reported to have provided arms to Hamas, and has cooperative relationships with Pakistan as well. Economic warfare would be bearish for US dollars and US Treasury bonds.

3. While neither Hamas nor Israel is directly in the business of oil, conflict in the Middle East tends to increase the likelihood of supply lines being attacked, intentionally or not. Moreover, whether or not actual supply is affected, the psychology of traders is, as evidenced by a spike in oil prices at the onset of the conflict. 24/7 Wall St notes that Iran benefits from higher oil prices, and as a source of funding for Hamas, and thus there are economic incentives that play into prolonging/exacerbating the conflict as well.

4. US Defense ETFs naturally benefit from the greater likelihood of war, particularly if it becomes seems more likely that the United States will get involved. In particular, PoweShares Aerospace & Defense ETF (PPA) may be an interesting play from a technical perspective; the market is making a double top formation and is testing its November 4 high of 14.69. This could be a nice "break or bounce" play, in that a break above 14.69 coupled with momentum indicators and expansion of war could be a buying opportunity, while a bounce off this level coupled with successful peace talks could represent a short selling opportunity. The chart below illustrates.


Disclosure: Long gold.

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uahmed

Hello Simit,

Could we also go long CHF (swiss)?

Ali

Simit Patel

Hi Ali,

That seems like a good possibility, given Switzerland's neutrality and its status as a safe haven. I think JPY could be a big beneficiary of any form of dollar weakness as well.

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heath

The Yom Kippur War and its aftermath are useful reminders that war is a
destructive and often unpredictable business, one that usually hurts the overall investment.War always creates problems never ends it. The same is happening with Israel as money and human recourse is being wasted in war.

Simit Patel

i agree 100%, heath. great comment.

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