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One issue we’ve been keeping a wary eye on over the past few months is Iran’s attempts to get the bomb.
Cutting through the rumour and counter-rumour, the issue boils down to three simple facts. 1) Iran wants to get the bomb, 2) Israel (and others) think that this would be a disaster, while 3) the White House wants the whole issue to go away.
For the past few weeks things looked like they might have been getting better. Iran seemed to have its hands full with other problems, including defending its brutal ally in Damascus. After some false starts, sanctions seem to be finally hitting Iran’s economy. There was even hope that the Saudi decision to increase oil output would keep prices falling.
Taken together, these two factors would hit Iran’s export revenues. This could force Tehran to make real concessions. Indeed, a recent poll on a state website suggests that most people in Iran want to cut a deal.
Sadly, it doesn’t seem to have got through to their leaders. Indeed, Tehran seems to have doubled down, with politicians threatening again earlier this week to shut off a key waterway to countries that support sanctions, and speed up enrichment. This has helped pushed oil prices upwards (though the European deal has also played a role in crude’s resurgence). However, this may only be the start. Here’s why the crisis is entering a critical phase.
Why enrichment matters
The hardest part of building a nuclear bomb is getting enough high quality uranium together. This is the material that produces the nuclear explosion. In its raw form uranium is far too impure to be of any use. So it needs to be enriched.
This involves taking the pure uranium from the rock by turning it into a gas, then spinning it in a centrifuge. To build a bomb, experts agree that you need 90% purity. For now, Iran is currently producing uranium to 19.75% purity.
That doesn’t sound like a problem, But the earlier stages are the hardest – and take the most time. So while it has taken several years for Iran to get to this stage, it will be very easy to complete the process, should it choose to do so. In the worst-case scenario, Iran could acquire enough material for a bomb in a month.
This makes the rumours that Iran is to starting to enrich uranium beyond 19.75% critical. This suggests that Iran has produced enough material to embark on producing a bomb. It would also force Israel to make a decision within a month.
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Shutting down the Strait of Hormuz
The second part of Iran’s threat could also have a major impact. As we’ve pointed out before, a fifth of the world’s oil supplies pass through the Strait of Hormuz. Although there are long-term plans to build pipelines to reduce its importance, these will take too long to be of any short-term use, and in the meantime any disruption would cause prices to spiral.
In response the US has been forced to send more ships to the area. It has also brought some stealth warplanes. However, Iran has upped the ante again by publicly testing long-range missiles that could not only hit US ships but could even strike bases.
Of course, the chances of Iran taking pre-emptive action are still small. Indeed, the calls for a partial closure of the strait come from the Iranian parliament, not the Supreme Leader. However, the fact that it is even being discussed shows that many in the regime support such an action. It is also a clear signal that Iran can, and will, respond to any Israeli (or US) action.
Chances of Israeli action are getting higher
Clearly it would be best if Iran blinked and gave up its nuclear plans. But as an investor, it’s worth being aware that the chances of some sort of action are higher than many people seem to think – and more of a threat than markets are pricing in.
The failure of sanctions to curb Iran’s nuclear goals mean that Israel will feel forced to act. Indeed, there is clear evidence Israel is getting impatient at what it sees as US apathy. It is also worried that Iran is developing strong links with the newly elected Egyptian government.
So what can you do as an investor? As far as we’re concerned, oil price-related plays aren’t the best way to protect yourself. Yes, an airstrike or attempt to close the Strait of Hormuz would send prices higher – possibly even above the levels at which they started the year.
But there are also clear downside risks to the oil price, particularly if the low growth in the eurozone area and the slowdown in China continue.
A far better option would be to buy gold. Not only is it a tremendous hedge against the inflation that would result from higher energy prices, it would also benefit from concerns about geopolitical instability.
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Matthew Partridge
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