ISIS and the Oil Riches of Arabia

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Slap! US stocks took a whack overnight, with the Dow Jones Industrial Average dropping nearly 300 points. That’s the steepest decline in three weeks. The US markets aren’t holding the gains from their highs in late December. It’s going to be choppier waters over there for a while.

As far as US markets are concerned, we are now trading in the late January to April timeframe my colleague Phil Anderson forecasted last year to end the run up in US stocks. According to him, we’re entering a period of volatility, most likely downward, or at best, sideways. The good news out of the US you’re hearing now is already priced in. But note, this isn’t foreboding a collapse. US markets are due a retrace. So brace yourself, but don’t panic.

Mind you, right now there’s not much to complain about in our neck of the woods, especially if you have Commonwealth Bank [ASX:CBA] in your portfolio. It hit an all-time high of $87.63 yesterday. And Telstra [ASX:TLS] is trading at its highest in 13 years. In a zero interest rate world, investors are hungry for yield.

US markets have risen a lot higher than Aussie stocks in the last few years. Can the US retrace and not take our market down with it? Hmm. The downward pressure on the US market is being attributed to the strong US dollar putting a drag on earnings growth for the big US international blue chips.

The inverse is true here, and the falling currency is taking some of the pressure off the RBA to cut interest rates. Aussie exports are looking a lot more competitive with our dollar now down below US 80 cents. But will the European Quantitative Easing (QE) bid up the Aussie again?

When the Swiss National Bank pegged the franc to the euro, they bought 100 billion worth of Aussie dollars. The European Central Bank action is about to pump out ten times that amount. Some of it is bound to come our way.

Europe’s QE offensive is part of the central bank war on deflation. That’s not being helped by the oil price. Both the Brent and West Texas benchmarks are still under US$50 a barrel. That’s deflation — the good kind. This lowers costs for business and consumers. Central banks would rather see this price go up. That’s how insane these people are.

You’d expect oil prices to stay depressed for the foreseeable future after such a big decline. But markets never make the outlook easy. Because the outlier risk in the oil market is the potential invasion or collapse of Saudi Arabia. I’m sure you read or heard about the recent death of Saudi King Abdullah.

But the country’s more pressing problem is the surrounding unstable states and groups openly hostile to the House of Saud regime. It may very well face an insurrection from within, too. Succession might make the country look even more vulnerable.

To show what I mean, have a look at this handy map produced by my colleagues over in the US at Outstanding Investments. Note that Yemen to the south is breaking down into civil war. Iran and Saudi Araba have been locked in a proxy war for years as they finance different factions in the area.

Saudi Arabia’s Troubled Neighbourhood

Source: Outstanding Investments

But Saudi Arabia’s biggest problem is the group ISIS. Military strategist John Robb, who spoke at our WWD investment conference, has been tracking this closely recently.

Robb claims that Saudi’s continuing to pump oil and allowing the price to stay down is actually an attempt cut down ISIS’ major source of funding. That’s illicit oil sales from the fields of Iraq.

Saudi Arabia is home to the Islamic holy cities of Mecca and Medina. Control of Arabia would hand those to ISIS, as well as control of the world’s largest oil reserves. Control of the Rent of natural resources drives geopolitical situations like this.

In Cycles, Trends and Forecasts, we show you why. If US ground troops are committed to the deserts of Saudi Arabia, it will be to protect the oil fields in the East. Saudi Arabia is a glittering prize — for both sides.

It’s also a totally unnatural country, whose founding ‘father’ Ibn Saud stitched together violently early last century. Later he appropriated most of its stupendous oil wealth for himself and his family and bequeathed autocratic rule to his heirs. The entire country could splinter back into the regional tribal areas from which it was born.

The cultural glue of Saudi Arabia is the fundamentalist brand of Wahhabi Islam. That means the Saudi population could easily greet ISIS troops as holy warriors, not as invaders.

This scenario isn’t total speculation, by the way. ISIS recently killed the Saudi general Oudah al-Belawi, who was in charge of securing Saudi Arabia’s northern border. Earlier this week Germany announced it was suspending arms sales to the country because of ‘instability’. That trade was worth US$400 million in 2013.

Bryon King at Outstanding Investments saysthe Saudi border guards have been ordered to ‘shoot to kill’ unauthorised entrants from Yemen and Iraq. The Saudi regime will do everything to preserve their power and control of the oil riches.

It’s notable that US President Obama declined to attend the solidarity march in the wake of Charlie Hebdo, but made a trip to Riyadh, the Saudi capital, to meet new King Salman bin Abdulaziz.

Suffice to say, the regime may survive, so enjoy low petrol prices, but don’t take them for granted.

Callum Newman
for The Daily Reckoning Australia

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Callum Newman

Callum Newman

Callum Newman is the editor of The Daily Reckoning and Associate Editor of Cycles, Trends and Forecasts. He also hosts The Daily Reckoning Podcast. Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect. To have Callum’s thoughts and insights on the current state of the currency, commodities and stock markets delivered straight to your inbox, take out a free subscription to The Daily Reckoning here.

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