Financial markets began the New Year with a positive note. While the sovereign debt crisis in the Eurozone remained worrisome, market sentiment was buoyant by improvement in the US. The dataflow in the US contained some pleasant surprises with the most eye-catching one being the employment report for December. The number of non-farm positions increased +200K in December, up from a downwardly revised 100K gain a month ago. The market had anticipated an addition of just +150K in December. The rise in payrolls lowered the jobless rate to 8.5% from 8.7% in November. Released earlier in the week, data suggested that US' manufacturing activities and the housing market also improved.
Crude oil started 2012 with a firm footing, mainly due to concerns over supply shortage as driven by sanctions on Iran and its threat to close the Strait of Hormuz. Iran's test of missiles near the Strait of Hormuz last week was interpreted as a threat that it has the ability to take more aggressive steps to close the gateway if the West imposes more sanctions on the country. An Iranian naval leader said the country has 'comprehensive control over the strategic waterway' and that sealing it to vessels would be a 'very easy task for Iranian forces. For the US, the Strait is an 'economic lifeline' and that 'interference with the transit or passage of vessels through the Straits will not be tolerated'.
According to the DOE/EIA, the Strait of Hormuz is the world most important chokepoint with an oil flow of almost 17M bpd in 2011. It's located between Oman and Iran, connecting the Persian Gulf with the Gulf of Oman and the Arabian Sea. Last year, almost 20% of oil traded worldwide flew through the Strait. Moreover, over 30% of the world's LNG flows through the Strait. Indeed, 70% of the UK's LNG imports and over 80% of India's transit Hormuz.
The DOE/EIA also stated that closure of the Strait would require the use of longer alternate routes at higher transportation costs. One option is the Petroline (a.k.a. the East-West Pipeline) which is 745 mile long. Petroline has a capacity of about 5M bpd. Oil could also be pumped north through the Iraq-Turkey pipeline to the port of Ceyhan on the Mediterranean Sea. However, volumes have been limited by the closure of the Strategic pipeline linking north and south Iraq.
Iran is OPEC's 2nd largest oil producer and the 3rd largest crude oil exporter in the world. According to DOE/EIA, export volumes to China, India, South Korea and Turkey increased in the first 6 months of the year. It's probably due to the fact that these countries have imposed less stringent sanctions on Iran. During the period, export volumes to Italy and the UK have decreased.
In recent days, the EU has unveiled intention to place an embargo of Iran's oil and details on the issue will be disclosed after a meeting on January 30. Although individual member countries might have different opinion towards the embargo (for instance, Italy has questioned the scope and timing of the policy while Greece has agreed to cooperate with the embargo), a consensus should have been made and sanctions are likely.
Both sanctions and the threat of closing the Strait of Hormuz have raised concerns that oil supply will be suspended, thus lifting oil prices. Although we believe the closure is unlikely as Iran will only use is as the resort, market sentiment will continue to affected by the Iranian issue in the near-term.
Gold also began the New Year with a positive note. While the +3% gain last week has not yet brought the yellow metal out of the corrective mode, we remain bullish and believe the global economic backdrops and monetary policies will eventually bring gold to new highs later in the year.
Gold peaked at 1923.7 on September 6, 2011, the same day as the SNB announced to set a 1.2 floor on EURCHF. The coincidence probably suggested that SNB's intervention had suffocated safe-haven trades despite dismal macroeconomic outlooks. Gold's sharp correction since then has been driven by factors such as strength in the US dollar, CME's margin requirement and the Fed's implementation of operation twist instead of QE3.
The US dollar may have further room to rise in the first half of the year amid ongoing sovereign debt crisis in the Eurozone and the relatively strong economic improvement in the US. The outlook in the second half of the year is more uncertain as it depends on the pace of recovery in European economies, fiscal tightening in the US and the FED's implementation of QE3. With the view that the strength of the greenback is cyclical rather than structural, it's prudent to expect the greenback to finish its gains in 1H12 as problems such as fiscal deficits and high unemployment rate linger. As US weakens, gold would probably strengthen.
As we mentioned, the US has its own deficits and economic problems. Indeed, stronger-than-expected economic indicators released recently were likely temporary. Should economic data return to the weak side, the Fed may be pushed accelerate its easing monetary measures to stimulate growth. The phenomenon would benefit gold due to its positive correlation with negative US interest rates.