This week, markets were trying to assess the impact of the military escalation in the Middle East on different markets. Let’s break down the main developments of the narratives and capital flows during the week of activation of the conflict.
The obvious reaction to the military escalation was gaps for Crude oil futures and Gold. While the latter is usually associated with protection against all kinds of risks, the market has started to promote a different narrative: a possible inflation spike following the rise of Crude oil.
As a result, there were three major capital flows observed starting from Monday, March 2nd: rising US dollar and yields of US treasury bonds (indicating the regime of “flight to safety”), rise of Crude oil and Natural gas futures. The first was the result of a possible disruption to oil and gas production and transportation.
The turmoil in the markets resulted with choppy action for the most asset classes, with controversial reactions for Gold and currency pairs.
30-year treasury bond yields. Source: https://www.cnbc.com/quotes/US30YAs the new information comes in, traders are in a “wait-and-see” mode, with the NFP publication in focus. Crude oil futures continue to climb pushing Brent over $85 and WTI over $80 per barrel.
Brent crude erased intraday losses as reports confirmed maritime traffic in the Strait of Hormuz has come to a near-complete standstill. The recovery follows a brief cooling of the market after an 18% rally over the first four days of the week, during which US officials attempted to intervene and stabilize energy costs.
Meanwhile, the US dollar remained largely unchanged despite the initial reaction of growth.
Let’s try to highlight possible scenarios of the development of this situation in application to financial markets. The initial liquidity shock and sell-off across all asset classes doesn’t seem to escalate, as markets rather displayed a whipsaw-type of action.
The possible medium-term idea for any type of shock and turmoil would be Gold (on the long side). Though, the initial reaction of Gold is usually a sell-off, as the market eliminates the excessive speculative inventory, after which usually it gets in play.
It was so during the majority of major market corrections: in 2008, in 2010-2011, 2020. The open interest and volume in Gold futures according to the information from CME group was elevated this week, so we may expect some action to happen soon.
Gold futures open interest and volume. Source: https://www.cmegroup.com/markets/metals/precious/gold.volume.htmlIn which scenario Gold might continue diving deeper? The possible liquidity shock and massive “flght-to-safety” regime could be
Now, let’s dive deeper into the price action and try to chart possible scenarios for Gold and S&P500.
XAUUSD
From a technical point of view, Gold had retraced to the dynamic support zone after the initial sell-off after closing the Monday’s gap. Given the muted dynamics of other potential safe haven assets, Gold may come into play soon as the clear alternative to other defensive options and cash, which makes sense only if there would be the massive liquidity crisis (otherwise there are no reasons to hold cash for investors).
If gold would bounce off the support as shown at the chart, it may reach the previous all-time-high in a short time period.
XAUUSD, daily chart. Source: Exness.comS&P500
The situation with S&P 500 looks muted now, but the more time passes by with higher oil prices, the correction becomes more possible.
The same pattern was observed before the most furious sell-offs: the market very slowly shifts the paradigm from growth to a correction and risk-off regime: it may take 2-3 weeks of continuous disruption of oil prices and supply chains to observe the effect on S&P500.
Though, we may suggest that if market conditions won’t change, if oil prices continue to rise and if there’s no resolution of the Middle East crisis in the near future, the possible destination of S&P500 would be down toward the correction as shown at the chart.
US500, daily chart. Source: Exness.com
