Geopolitical risks are on the rise.
While this has had limited impact on financial markets so far, history tells us that this can change on a dime: geopolitical risks don’t matter until they do.
Should you be hedging against these risks right now? I think so.
Iran upped the ante in its nuclear negotiation with the US and Europe last week by (1) demanding immediate removal of all sanctions and (2) backtracking on all the compromise language on rolling back its nuclear program that it had agreed to over the past year.
As I have argued elsewhere, Iran is likely emboldened by backing from Russia and China. Tehran and Moscow announced last month that they would soon sign a strategic cooperation agreement much like the one that Tehran signed with Beijing earlier this year.
The US and Europe are now facing a serious dilemma:
If they go on with the talks, they may be allowing Iran to buy time. The French Foreign Minister said on Wednesday:
“We have the feeling the Iranians want to make it last and the longer the talks last, the more they go back on their commitments...and get closer to capacity to get a nuclear weapon."
If they walk away from the talks, it will give Iran the excuse to increase its stockpile of enriched uranium and move towards 90% purity. On Nov. 5, Iran said that it had increased its stockpile of 60% enriched uranium to 25 kilograms.
The fact that President Joseph Biden is viewed as a weak leader by most Americans, especially following his hasty retreat from Afghanistan, likely makes it politically difficult for him to accommodate Iran’s new demands even if he wanted to. Indeed, indications from Washington over the past week suggest that Biden is getting ready to disengage. If this turns out to be case, it will mean that Biden has given up restoring the 2015 nuclear agreement with Iran, one of his key foreign policy goals.
Time is running out for the world to stop Iran from getting a bomb. It is thought that Iran can produce enough 90%-enriched uranium for a single nuclear bomb within a month. With sanctions having failed to deter Iran’s nuclear ambitions, is Biden prepared to take military action? Israel, the key US ally in the region, has long maintained that only a “credible military threat” can discourage Iran.
Iran seems to have already answered this question for themselves. It is reasonable to assume that the decision by the Iranian leadership to harden their negotiating position is at least partly based on their view that Biden is “weak,” and that he is unlikely to attack. Moreover, Tehran is probably also gambling that the new Israeli government, consisting of 8 coalition parties with disparate views on how to deal with Iran, is unlikely to act unilaterally, despite continued strong rhetoric out of Jerusalem.
Because Iran seems to have already answered this question, I think it is safe to assume that the termination of the talks will be followed by a rapid acceleration in the pace of Iran’s nuclear program.
I strongly suspect that my conclusion is shared by the thousands of analysts at the State Department and the Pentagon who do this kind of thing for a living.
If I am right, to turn the tables, Biden’s next step will be to convince Iran that he is not weak, that he is prepared to attack if necessary. The strong do not have to do very much to persuade others that they are strong. However, a weak president such as Biden, has his work cut out for him if he is to change Iran’s perception of his administration.
Indeed, over the past week, Biden has been trying to look tough. He decided on a diplomatic boycott of the Beijing Winter Olympics, he told President Vladimir Putin over the phone that he would send weapons to Ukraine if Russia were to attack, and he is sending a team to the UAE to tighten the enforcement of sanctions against Iran.
But he would have to do a lot more to convince China, Iran and Russia that they are dealing with a wolf and not a lamb.
In my view, this is the greatest risk facing the market right now: with Biden sounding more aggressive on Iran, China and Russia, these countries will try to test him, individually and together.
How can investors hedge against the risk that a war of words spins out of control? I have been recommending to the subscribers of my blog to look at oil majors like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) as high dividend investments that are also a good portfolio hedge against geopolitical risks.
Russia is the second largest oil exporter in the world, and the second largest oil exporter to the United States. Iran has the fourth largest oil reserves in the world. China is the largest oil importer in the world and Iran’s largest oil export market.
Real escalation of tension between the US and the China-Iran-Russia axis will likely increase the supply risk premium in the oil market, especially as we head towards a winter that because of La Nina is likely to be colder than usual in the Northern Hemisphere. The coming cold winter might persuade Russia and Iran that they are the ones with real leverage.