🍔Could Oil Go To $200?

Our tactical dip-buys made a small profit

Welcome back to MktContext where we study the US economy and time the stock market.

Our tactical longs in IWM/SPX given last weekend made a small profit. We expected Trump to off-ramp from Iran, and that has indeed occurred. However since then, the war has escalated and a resolution appears further away.

This week’s note discusses the latest developments and how we see oil prices playing out in the near-term. Importantly, we discuss why this shouldn’t drive inflation nor impact the US. Too many people are calling for a recession but historical data does not support this view.

We also discuss technical analysis and positioning in the market. The market is heavily short or hedged, which raises the possibility of an upside squeeze. This could be the dip to buy!

Today’s topics: Update on Iran war, oil prices, inflation, impact on economy, liquidity, technicals, and our portfolio positioning.

Fog of war

The situation continues to develop in Iran, with both sides ratcheting up tensions and the Strait of Hormuz still closed to most shipping traffic. There’s been a mix of escalatory and de-escalatory words/actions from both sides, which leaves market observers more confused than fearful. Here’s a smattering of headlines from this week:

• Trump declares war “pretty much complete”; IRGC declares war is still on

• Israel launches new wave of strikes; Iran retaliates

• Iran president announces willingness to de-escalate

• Neighboring ships and ports attacked in the Persian Gulf

• Trump insists war will end soon, but plans at least two more weeks of strikes

• Reports of sea mines being planted in Hormuz; Deputy of Iran denies it

• Iran moves from reciprocal to continuous strikes

• Khamenei’s son, Mojtaba, announced as successor but is gravely injured

• Mojtaba keeps Hormuz shut and threatens to open new war fronts

• Several US military aircraft hit

• US bombs Kharg Island (Iran’s major oil export terminal)

So where does the war stand today? After naming Khamenei’s son (a more extreme version Khamenei senior) as successor, Iran is putting up strong resistance and counter-attacking US and neighboring Gulf countries.

Iran has also shut down the Strait of Hormuz, through which much of the world’s oil supplies and other commodities transit. Iran is now holding the world’s oil hostage, and won’t stop until it gets lasting guarantees of protection. This is their key bargaining chip.

As we expected, Trump declared the war is “nearly complete” which gave brief reprieve to markets. But Iran is pulling all stops and refuses to negotiate nor surrender. This puts Trump in a difficult position: He can’t withdraw, lest he cede the strategic Hormuz chokepoint and also face embarrassment of failure.

At the same time, Israel wants to topple the Iranian regime and see the war to its full conclusion.

Trump’s only option is to raise the stakes and fight on. Airstrikes can only get them so far when nuclear targets are underground and Iranian militia are dispersed. Hence we are now hearing rumors of a possible ground invasion by US troops. Trump is trying to up the ante against an opponent who will not fold; we fully expect escalatory actions over this weekend.

In our estimation, the next step for the US is a ground invasion to take/destroy Iran’s 460kg of Uranium stockpiles and oil stockpiles/infrastructure. Only then might Trump announce “mission accomplished”. But not only is this a Hail Mary, it doesn’t actually do anything to reopen Hormuz nor get the Iranians to fold.

Mosaic defense

What has surprised us so far is Iran’s ability to put up resistance despite losing much of its weaponry. With a couple of low-cost drones and fast boats, Iran can plausibly threaten Hormuz for as long as it wants. A remarkably cheap way to deprive the world of oil. The world is witnessing a new era of drone and AI warfare in real-time.

There are different proxy groups and decentralized military forces (31 provincial commands acting autonomously with their own weapons, intelligence, and decision-making!) operating in Iran. This is called “Mosaic Defense”. It’s also why killing the leaders does nothing to the regime or its battle capabilities.

Therefore, this war is unlikely to be winnable for the US without heavy troop casualties and draining financial resources. Iran has ways of prolonging the battle, while the US has already spent $25B and years’ worth of supplies in just two weeks. The US is quickly running out of high-tech munitions — these weapons require complex manufacturing, with years of backlog from underinvestment.

At the same time, there has not been enough financial distress to push the US to abandon its objectives. Neither has Iran felt they’ve inflicted enough harm to extract maximum leverage. In short, the war rages on.

The key question is what this means for oil prices and the global economy…

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• Could oil go to $200?

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• Liquidity is weakening

• Technicals are poised to squeeze

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