The complacency and calm that had lulled investors into a dreamlike state has been shattered, replaced by surging oil prices and horrific scenes out of northern Iraq.
An extremist Sunni terrorist group known as the Islamic State in Iraq and the Levant (ISIL, or ISIS, depending on translation) — which could actually be considered a small army at this point — continues its push toward Baghdad and is nearing key oil production and refining infrastructure.
As a result, stocks suffered their worst weekly decline in two months as gold and oil prices surged in response. Traders are jumpy, as evidenced by a down-and-up churn near the closing bell on Friday related to rumors that Iraqi Prime Minister Nouri al-Maliki had been killed.
With the situation on the ground in Iraq deteriorating fast, more market volatility is likely heading into next week’s Federal Reserve policy meeting. Here’s why:
ISIS has already taken Mosul, Iraq’s second largest city, and captured tanks, helicopters and other equipment as well as hundreds of millions of dollars from a central bank branch there. The Kurds in northern Iraq have taken Kirkuk and its oil field. And the country’s Shiites are calling for Iranian allies to help.
So basically, it’s a mess.
Wholesale gasoline prices have surged to levels not seen since 2013, and are now just 10% from the all-time highs hit in 2011 and 2012.
Further gains look likely before this is all done.
The large Baiji oil refinery in northern Iraq, with a 310,000 barrel per day capacity, is reportedly still under government control. And the large Iraq-Turkey oil pipeline (ITP) that runs north has been shut for maintenance since March and hasn’t been damaged.
But should ISIS take Baiji (protected by Iraqi special forces at the moment) or destroy or damage the ITP, oil and gasoline prices could shoot much higher. There’s another large oil refinery, the Daura facility, in the disputed region with a capacity of 300,000 barrels per day.
Overall in April, Iraq produced 3.34 million barrels per day vs. a sustainable production capacity of 3.65 million barrels, according to Deutsche Bank.
It’s worth remembering that a similar geopolitically driven rise in energy prices in 2011, caused by the Arab Spring uprising in Libya and elsewhere, resulted in a spike in inflation that forced the Fed to end its “QE2″ bond buying program on schedule. The pullback in stimulus ushered in a tumultuous summer of trading that year ending in the most violent correction of the bull market thus far that August.
Click to Enlarge Watch for comments about the upward drift in inflation in the Fed’s policy announcement next week. Any hint that price pressures could force a sooner-than-expected short-term interest-rate hike could really rattle this stimulus-addicted market.
For now, I continue to recommend investors remain cautious with a focus on the safe-haven and inflation-production qualities of precious metals and the related mining stocks. NovaGold (NG) is up more than 18% since I added it to my Edge Sample Portfolio back on June 5.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, he had recommended NG to his clients.