Count-down to War with Iran? Mixed Signals from Crude Oil, Gold, and Tel Aviv

By: Gary Dorsch | Mon, Mar 13, 2006
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It seems like déjà vu all over again. This time, the Bush administration has its sights on the most dangerous member of the "Axis of Evil", with time running out before the Ayatollah of Iran acquires the technology to build nuclear weapons. But while the saber rattling between the US and Iran ratcheted to new heights last week, the price of crude oil and gold were plummeting on world markets. In Tel Aviv, a likely target for dozens of Iranian Shahab missiles, equities are buoyant.

The war of words between the Bush administration and Ayatollah Ali Khamenei of Iran and his surrogates escalated to new heights on March 9th, when US Secretary of State Condoleezza Rice told lawmakers on Capitol Hill, that "We may face no greater challenge from a single country than from Iran, whose policies are directed at developing a Middle East that would be 180 degrees different than the Middle East we would like to see developed," she said.

"If you can take that and multiply it by several hundred, you can imagine Iran with a nuclear weapon and the threat they would then pose to that region." Ms Rice said Iran seemed determined "to develop a nuclear weapon in defiance of the international community. Iranian support for terrorism is retarding, and in some cases, helping to arrest the growth of democratic and stable governments in the Middle East," she added.

The previous day, on March 8th, US defense secretary Donald Rumsfeld told a news conference, " Iran is currently putting people into Iraq to do things that are harmful to the future of Iraq. We know it, and it is something that they will look back on as having been an error in judgment," he added.

And on February 7th, Vice President Dick Cheney declared that Iran will not be allowed to have a nuclear weapon, "the United States is keeping all options on the table in addressing the irresponsible conduct of the Iranian regime, which continues to defy the world with its nuclear ambitions. The Iranian regime needs to know that if it stays on its present course, the international community is prepared to impose meaningful consequences," Cheney told an AIPAC conference.

But Iran's supreme leader Ayatollah Khamenei declared on March 9th, the "Islamic republic of Iran will continue its drive towards mastering nuclear technology. The Iranian people and the officials of the Islamic republic of Iran are more powerful than before and like steel, will stand against any pressure or conspiracy," he said. On March 20th, the Ayatollah will be demanding Euros instead of US dollars for Iranian oil exports, following the strategy of Iraq's former strongman Saddam Hussein.

Iranian president Mahmoud Ahmadinejad added on March 9th, "The Western countries know that they are not capable of inflicting the slightest blow on the Iranian nation because they need the Iranian nation. They will suffer more and they are vulnerable. Our enemies will never succeed in forcing the Iranian nation to step back on its rights over peaceful nuclear technology because it never accepts humiliation. This nation will not allow others to treat it with a bullying attitude, even if those who treat it with a bullying attitude are international bullies," he declared.

Senior Iranian national security official Javad Vaeedi said Tehran would inflict "harm and pain" to match whatever punishment Washington persuaded the UN Security Council to dole out for Tehran's refusal to give up atomic research. "So if the United States wishes to choose that path, let the ball roll. The US may have the power to cause harm and pain but it is also susceptible to harm and pain," Vaeedi said.

On March 10th, Iran's interior minister Mostafa Pourmohammadi threatened to use Iran's own oil and gas supplies and its position on a vital Persian Gulf oil route as weapons in the international standoff. "If the UN tries to politicize our nuclear case, we will use any means. We are rich in energy resources. We have control over the biggest and the most sensitive energy route of the world."

"An attack on Iran will be tantamount to endangering Saudi Arabia, Kuwait and, in a word, the entire Middle East oil," said Iranian Expediency Council secretary Mohsen Rezai. Iran already has complete control over 10% of the world's oil reserves and 25% of its natural gas, and has partial control over the narrow Strait of Hormuz, the only waterway in and out of the Persian Gulf. Between 16.5 million and 17 million barrels of oil per day move through the Strait of Hormuz. That's about a fifth of the world's oil, including supplies from Saudi Arabia, Kuwait, Iran and Iraq.

And on February 22nd, Israeli interim Prime Minister Ehud Olmert responded to Iran's Ahmadinejad's questioning of the Nazi Holocaust and calls for the Jewish state to be "wiped off the map". "The president of Iran, with all of his statements, is a heinous anti-Semitic phenomenon. He is an Israel-hater," and he said Iran is just months away from acquiring the know-how to make nuclear weapons. "We must prevent Iran from reaching a technological know-how, with everything that entails, and the international community has the tools to deal with this," he said.

Russian kingpin Vladimir Putin and Egypt's Mohammed ElBaradei, chief of the IAEA, devised a flawed proposal to allow Iran to gain the technology to build a nuclear weapon, but US State Department spokesman Tom Casey quickly shot down the idea on March 6 th. "You can't be just a little pregnant. You can't have the Iranian regime pursuing enrichment on any scale, because pursuing enrichment on any scale allows them to master the technology, complete the fuel cycle, and then that technology can easily be applied to a clandestine program for making nuclear weapons."

Yet, although the drumbeat of war in the Persian Gulf is getting louder, the price of US light crude oil formed a "double-top" pattern at just below $70 per barrel in late January, and then crashed to as low as $57.50 per barrel in mid-February. For the first time in 3-years, OPEC appears to have regained some of its old magic over the crude oil market, and has deflated the Iranian "War Premium" by vowing to maintain full oil production at 28.0 million barrels per day (bpd) throughout 2006.

Global demand for crude oil normally declines by about 2 million bpd in the second quarter, so without a timely cut in OPEC output, a mini glut of oil could develop in the months ahead. The OPEC cartel is taking a calculated risk that prices will stay high despite the oversupply. On March 8th, Saudi Oil Minister Ali al-Naimi said concerns about supply disruptions in Nigeria, Iran and Iraq were buoying prices.

"OPEC should not take any decision to decrease production because any such decision would be the main reason for price hikes," Naimi told the Al Hayat newspaper on March 6th. "We know the reason for the current increase in prices and it is the fear about anything that would cut supplies," al-Naimi said.

"We expect the geopolitical problems to persist so the risk that prices go up still exists," said Algerian oil minister Chakib Khelil, adding "the market is well supplied and I do not think we are taking a big risk." OPEC president, the Nigerian Edmund Daukoru said that global economic growth in 2006 would be 4.3% "which shows the world economy has until now resisted the hike in prices."

Until recently, increases in OPEC oil output from 23.5 million bpd to a record 28 million bpd had failed to stop US crude prices from climbing by $45 per barrel to as high as $70 per barrel. But for now, it looks as if Riyadh has capped oil prices at $70 /barrel. But the slide in crude oil prices is also linked to expectations of a coordinated round of tightening by the Bank of Japan, the Fed, and the European Central bank, making hedge funds jittery. Still, buoyant Asian and European equity markets signal that liquidity in Euros and Japanese yen still remains abundant and cheap.

But Israel is not the only country in the region that fears the possibility of a nuclear armed Iran. If the Ayatollah gains nuclear invincibility, he could terrorize the entire Persian Gulf region, including the Arab oil kingdoms and gain total control over the world's oil jugular in the Strait of Hormuz. Therefore, Saudi Arabia, Kuwait, and the UAE might like to see oil prices fall into the $50 to $55 per barrel range to help reduce the potency of Iran's "Oil Weapon" in the months ahead.

And if war does comes to the Persian Gulf this year, it is better that prices should start to shoot higher from a lower level than a higher level. The International Energy Agency says it would be able to plug the supply gap for a number of months were Iran to stop its oil exports. "The IEA would be capable of compensating for a number of months" said President Claude Mandil on March 9th. "According to my knowledge, OPEC would not be able to compensate in totality."

With OPEC pumping oil at full throttle, US crude-oil inventories have climbed to 335.1 million, their highest level since May 1999. The latest weekly gain was the biggest since Oct. 29, 2004, and left supplies 14% above the five-year average. The last time crude oil stocks were this high was in May 2005, when spot crude oil prices hovered around $48 per barrel. The $12 per barrel difference might represent what's left of the Iranian "War Premium" plus instability in Iraq and Nigeria.

US crude oil and gasoline inventories might be high because market participants can't rely on global spare oil production capacity, of which there is very little, to deal with any future disruptions in petroleum supplies, the US Energy Information Administration said on February 23rd. "Market participants are concerned about being able to get needed supplies, should something cause a drop in supply."

"As a result, many of them may be storing up additional inventories as a buffer should there be a supply problem at some point in the future. Thus, until either spare capacity increases significantly across the entire supply chain, or many of the perceived uncertainties in the market are removed, oil markets could see high inventories coexist with high prices for the foreseeable future," the US EIA said. The US Strategic Petroleum Reserve located in Louisiana and Texas, has been filled up to capacity at 700 millions barrels, as a buffer in case of a national emergency.

Also keeping oil prices high is China's oil demand, which is forecast to grow by 500,000 barrels per day to 7.2 million barrels per day in the first-quarter of 2006, the EIA said on March 7th. China is the world's second-largest oil consumer behind the United States, which consumes about 20.8 million bpd. Japan is the third largest consumer at 5.41 million bpd. Beijing is also interested in filling up its strategic oil reserves of up to 30 million barrels.

Saudi Arabia's oil minister Ali al-Naimi has complained that oil prices are artificially high due to excessive speculation by hedge funds. "Oil is attracting vast sums of money from hedge funds and institutional investors seeking to maximize returns and diversify their portfolios. The price today is not only influenced by fundamentals. The fundamentals of supply and demand for oil today are very sound, but the market is dancing to a different tune. Recent information indicates that even banks are jumping on the bandwagon," he said on April 21, 2005.

Financial markets have become so technologically sophisticated and global in nature that traders can borrow cheap money in Europe and Japan as much as they can in the US, to leverage their purchases of natural resource stocks, oil stocks, gold, or even Brazilian and Russian bonds, all benefiting from soaring commodity prices. To the extent there is a collective desire of the Group of Seven to contain inflation, it would require tightening by each of the big three central banks.

And for the first time in five years, the big-3 central banks, have telegraphed a coordinated round of monetary tightening in the months ahead, that would raise the cost of leveraging commodities such as crude oil and gold. Most importantly, the Bank of Japan has decided to scrap its five year old policy of "quantitative easing," and will gradually reduce excess liquidity in the Tokyo money markets by about 26 trillion yen ($220 billion) in the next 3-months. The BOJ is expected to sell short term bills to drain Japanese yen floating around the global markets, and buy fewer government bonds per month, and that could exert upward pressure on bond yields across the globe. The sharp decline of crude oil prices in February was partially linked to sliding prices for Euro-yen contracts in Singapore, signaling the end of ultra-easy money in Tokyo by the summer.

But there is still a glut of Euros floating in the Euro zone economy, interest rates are still very low, and providing fertile ground for takeover artists in European equities. "There is a considerable excess of liquidity, growth in M3 money supply and in credit were very dynamic. We see risks to price developments in the medium to long term. The trend is expansive," said Bundesbank chief Axel Weber on March 7th.

Austrian central banker Klaus Liebscher said the ECB's second quarter-point rate hike to 2.50% had done little to alter the generous monetary conditions in the Euro zone. "This increase was necessary in order to somewhat take back the accommodative monetary policy in the face of the risks to price stability. The interest rate level, nominal as well as real, is still very low," he said. Still, the ECB has jawboned a lot, but has done very little in draining Euros out of the money markets.

In Frankfurt, Euro Libor futures for December delivery have declined to the 96.65 level, for an implied yield of 3.35%, pricing in three additional quarter-point ECB rate hikes by year's end, and discouraging hedge fund dabbling in crude oil. For the first time in 5-years, the ECB is talking about tightening liquidity in the Euro zone, to help tackle energy prices, which were 20% higher year-over-year in January, and leading Euro zone producer prices 5.3% higher in January from a year earlier.

In the US, the influential New York Fed chief Timothy Geither said the central bank needs to tighten its monetary policy further to lift longer-term US bond yields, which have been kept artificially low, by up to 150 basis points, by irrational Asian central bank purchases. "Policy would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation. To do otherwise, would run the risk that monetary policy would be too accommodative."

Sliding US dollar Libor (Eurodollar) futures are taking some of the steam out of the high flying crude oil market. Chicago futures traders are betting the Fed will raise rates by a quarter-point to 4.75% on March 28th, and see good odds it will reach 5% by May. St Louis Fed chief Poole agrees. "We've got our best guess where we need to go. I think it is pretty well aligned with where markets think we need to go." Expectations of higher interest rates and weaker oil prices finally took their toll on the gold market last week, which fell $25 per ounce to $541.50 /oz in New York on March 10th. Sliding interest rate futures in yen, Euros and US dollars panicked hedge funds into unwinding long positions in key commodities. But eventually, the big-3 must back up their jawboning with action to keep gold and oil under wraps.

Central bankers are not happy to see gold prices move swiftly higher, because it's a clear signal in the marketplace, that they have abused and violated the public trust over the purchasing power of their currency. Higher gold prices put pressure on central bankers to restrict their money supply and raise short term interest rates, which runs counter to their primary mission of pumping up equity markets.

Still, gold has fared much better than crude oil in recent weeks, improving the gold- to-crude oil ratio to 9 barrels of oil from a low of 8.1 barrels in late January. The wave of mergers in the gold industry is putting more of the yellow metal into fewer hands, and helping miners to limit price declines and combat selling forays by European central bankers. South Africa's gold output fell 13.5% in January from a year earlier, helping to keep supply tight. And while Riyadh is aiming to drive oil prices lower to weaken the Ayatollah of Iran, the Saudi kingdom boosted its gold purchases by 10% to 160 tons in 2005, and the Emir of the United Arab Emirates bought 13% more gold or 106 tons last year, perhaps anticipating a flare-up of instability in the Persian Gulf region.

So far, global equity markets have reacted calmly to the certainty of future rate hikes by the big-3 central banks, and are enjoying the recent slide in crude oil prices to about $60 per barrel. There is a widespread sense of disbelief in the global equity markets that the Ayatollah's quest for nuclear weapons would result in military warfare, and instead, there is increasing confidence that oil prices have topped out.

Perhaps, global equity traders are betting that Moscow or Beijing can persuade the Ayatollah to give up his ambition of nuclear invincibility, as US Senator Joseph Biden suggested on March 12th, "I think we can stop them from having a nuclear weapon short of war." German Foreign Minister Frank-Walter Steinmeier warned against getting dragged into "sabre rattling" by antagonistic comments from Iranian officials. "This is the hour of diplomacy," he told the Bild am Sonntag weekly. Asked on BBC radio whether a military strike against Iran was conceivable, British foreign minister Jack Straw said on March 13th, "No American president is ever going to theoretically rule out any option, in practice military action is not on the Americans' agenda. This is an issue which has to be resolved, yes by pressure, but by peaceful and democratic means." For the UK's Straw and Germany's Steinmeier, a nuclear armed Iran is already a fait accompli, (ie long-term, bullish for oil and gold).

But the Ayatollah had already bought the Chinese veto at the UN, by dangling a $100 billion dollar contract before Beijing, which would allow China Petrochemical or Sinopec to develop the 26 billion barrel Yadavaran oil field. The deal would complete a memorandum of understanding signed in 2004. In exchange for developing Yadavaran, one China would buy 10 million tons of liquefied natural gas per year for 25 years beginning in 2009.

Vladimir Putin, the kingpin of Russia is the top weapons supplier to Iran and Syria, the arch foes of the US-Israeli alliance, and has $10 billion of contracts with the Ayatollah to build nuclear reactors in Iran. Russia's energy resources are now completely under the control of the state, after confiscating Yukos, and provide the Kremlin with a new weapon, Petro-Power. Putin is mostly interested in maintaining the balance of tension and terror in the Middle East to support high global oil prices, which are enriching Moscow's coffers and its foreign exchange and gold reserves to a record $197.9 billion as of March 3rd.

With a likely Chinese and Russian veto of any tough UN sanctions bill on the horizon, the Bush administration might play its best card short of military action to stop the Ayatollah from acquiring nuclear weapons - an embargo of refined gasoline sales to Iran. G asoline consumption is estimated at 64.5 million liters per day in Iran, while refining capacity is just 40 million liters per day, thus forcing Iran to import 24.5 million liters daily.

And Iran could face major shortage of refined gasoline by 2020, when consumption is forecast to stand at 308 million liters. Right now, the Ayatollah's regime spends $4.5 billion per year buying refined gasoline from abroad, mainly from Europe and India. Making matters worse, gasoline is subsidized in Iran at one-tenth of the cost in neighboring countries, so nearly 20% of Iran's gasoline supplies are smuggled outside of the country for a handsome profit.

The Bush administration might ask Europe, India, Japan and South Korea to join an embargo of refined gasoline exports to Iran. However, the Ayatollah has already sewn an intricate web of commercial oil relations with America's allies that could prove very difficult for Washington to untangle.

Japan currently buys 550,000 bpd of oil from Iran, and Japan's biggest oil developer, Inpex, is planning to develop the southern part of Iran's Azadegan, estimated to hold 26 billion barrels of oil. Japan is aiming to pump 150,000 barrels per day by mid-2008 and reach 260,000 bpd by early 2012, from southern Azadegan.

And India imports at least 150,000 barrels a day of Iranian crude. Tehran is offering to supply India with liquefied natural gas (LNG) in a deal valued at $22 billion. LNG exports would run for 25 years, starting from late 2009. India is also angling for stake in Iran's Yadavaran oilfield. New Delhi is planning to build a $7 billion gas pipeline from Iran through Pakistan to India. South Korea refines about 100,000 barrels a day of Iranian crude, and is involved in giant South Pars gas field, an investment worth about $1.6 billion. Turkey consumes about 140,000 barrels a day of Iranian crude. Royal Dutch Shell buys about 200,000 barrels a day of Iranian crude, and developed the Soroush - Nowruz oilfields, which required an investment of nearly $1 billion.

The European Union is already backing away from tough sanctions against Iran to protect its economic interests. Germany exported around 4 billion Euros' worth of goods to Iran last year, followed by France with $2.6 Euros, and Italy's 2.4 billion Euros. French oil company ToTal has invested heavily in Iran's oil and gas sector, in the development of the Sirri, Doroud and Balal oilfields, and South Pars gas field with Russia's Gazprom. And the Ayatollah has threatened to pull tens of billions of Euros from European banks if sanctions are enacted.

On March 10th, EU foreign policy chief Javier Solana sounded wobbly, "I do not rule out sanctions, but it depends on what kind of sanctions they are. We certainly do not want to hurt the Iranian people, (i.e. a gasoline embargo). It won't be easy for the Security Council." EU External Relations Commissioner Benita Ferrero-Waldner cautioned, "We have to think very carefully in order to maintain the consensus of groups and in particular of the Permament Five," including China and Russia.

It's unlikely that the UN diplomatic circus could adopt a gasoline embargo on Iran, but the Ayatollah has already made plans for rationing. Iran has some 2,000 filling stations that would be equipped with electronic payment systems using smart cards by October, the largest information technology project in the country, to be used at times fuel is to be rationed. Oil Minister Bijan Namdar Zanganeh had said earlier this year that gasoline coupons have been printed and would be distributed.

Iran is also implementing projects to build more refineries to boost gasoline output by seven to eight million liters a day within the next two years. Anglo-Dutch conglomerate Royal Dutch/Shell is the advisory partner with Iran in the project for Iranian refineries in terms of production, productivity, and number of workforce.

So that leaves Israel at risk of a nuclear holocaust. "If the UN Security Council is incapable of taking action to stop Iran from acquiring nuclear weapons, Israel will have no choice but to defend itself. We have the right to give all the security that is needed to the people in Israel. The Israeli approach is the US and the European countries should lead the issue of the Iranian nuclear program to the table of the UN Security Council, asking for sanctions," said Israeli defense minister Shaul Mofaz.

The Israeli Mossad and Western intelligence agencies believe that Iran would have the technology to build a nuclear bomb within three to six months, and could build the bomb in three to five years. So while the UN dithers away for a few more months, parading ineffective sanctions, either Israel or the US might be forced to mount a military strike on Iran's nuclear reactors in 2006.

Former Israel Defense Forces chief of staff Moshe Ya'alon said on March 9th that Israel has a military option to counter the Iranian nuclear threat, and that a strike on Iran could delay its nuclear program by several years. The intervening years, until Tehran got its program back on track, could see a regime change in Iran. He said that such a strike would be difficult to carry out from a military perspective as Iran's nuclear facilities are spread out, but he believed it was nonetheless feasible.

Israeli Defense Minister Shaul Mofaz told reporters in Germany on March 8th, that Israel had all it needed to defend itself against Iran. Asked if Israel had a military plan handy in a desk drawer to strike Iran, Mofaz said, "Israel has many drawers containing everything it needs to defend its citizens. Israel will not stand by idly while its very existence is at risk. We do not plan to turn a blind eye to these threats and we will do everything possible to make sure they do not materialize."

Yet despite the escalating war of words with Iran, the Tel Aviv-25 stock index is immunized, and trading near record highs, at almost triple its value from three years ago, following the overthrow of arch enemy Saddam Hussein. The TA-25 received an extra boost following the death of Yasser Arafat, which marked the beginning of a major reduction of terror attacks in Israel over the past 15-months.

Israel emerged from its worst economic slump ever in 2003, after former finance minister Benjamin Netanyahu, in April 2004, announced a reduction in Israeli corporate income taxes to 30% from 36% over four years. A sharp decline in the inflation rate allowed the Bank of Israel to lower 3-month shekel deposit rates to a record low of 3.50% in 2005, providing additional fuel for the TA-25.

The Israeli defense ministry says its Arrow 2 anti-ballistic missile system is capable of intercepting and destroying any Iranian missiles, even were they to carry nuclear warheads. Moshe Ya'alon did add that any Israeli strike against Iran would lead to a harsh retaliation against Israel. He said Iran might try launching missiles from its own territory towards Israel or to use the Hizbullah in Lebanon and the Hamas in Gaza in order to fire rockets into Israel. But Ya'alon said Israel can withstand such an attack, thanks to its effective anti-missile systems. Apparently, Israeli traders agree.

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Gary Dorsch

Author: Gary Dorsch

Gary Dorsch

Gary Dorsch

Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.

As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.

He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.

Disclaimer:'s analysis and insights are based upon data gathered by it from various sources believed to be reliable, complete and accurate. However, no guarantee is made by as to the reliability, completeness and accuracy of the data so analyzed. is in the business of gathering information, analyzing it and disseminating the analysis for informational and educational purposes only. attempts to analyze trends, not make recommendations. All statements and expressions are the opinion of and are not meant to be investment advice or solicitation or recommendation to establish market positions. Our opinions are subject to change without notice. strongly advises readers to conduct thorough research relevant to decisions and verify facts from various independent sources.

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