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Risks are rising for an oil price spike as tensions between the U.S. and Iran increase

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If not for the trade war, both oil and gasoline prices could be much higher than they are now on rising tensions between the U.S. and Iran.

Analysts say oil could be more than 10% higher, but if there is a resolution of trade issues, and the situation in the Middle East intensifies, there are risks of price spikes that take oil to as high as $100 a barrel this summer.

“If you do get a trade war resolution, a better economy coupled with Iran sanctions, that’s a recipe for higher oil,” said Francisco Blanch, head of global commodities and derivatives at Bank of America Merrill Lynch. Blanch said under that scenario, one incident could trigger a spike in Brent, the international benchmark, to $100 a barrel.

“I think the real risk is Iran misreads [President Donald] Trump and Trump misreads Iran. I do think the real risks are increasing for sure,” said Blanch. His forecast is for Brent to reach $82 per barrel during the summer.

West Texas Intermediate futures are flat this week at just around $62 per barrel and down 2.2% for the month so far, even though the U.S. has sent an aircraft carrier and bombers to the Gulf due to unspecified threats, which U.S. officials say are the work of Iran.

The U.S. Wednesday ordered all non-emergency diplomatic staff to leave Iraq, after two separate attacks in the region and as the U.S. responds to other nonspecific threats. This week, two Saudi tankers were among four ships attacked off the coast of the United Arab Emirates, and Houthi rebels, who have ties to Iran, claimed responsibility for a separate drone attack on a key Saudi Arabian pipeline.

While it’s not clear Iran was involved, analysts expect more such incidents.

“Senior Iranian officials have made veiled and not-so-veiled threats to obstruct the ability of its regional rivals to export oil and exponentially raise the economic costs of remaining on the current policy course. They have also warned of ‘planned accidents’ which could lead to direct confrontation,” notes Helima Croft, global head of commodities strategy at RBC.

The Houthi, operating from Yemen, have previously attempted attacks on Saudi oil infrastructure. Saudi Arabia and Iran are engaged in a proxy war in Yemen. Iran also provides funding for Hezbollah, a Lebanon based group designated as terrorists by the U.S.

The Saudi Aramco oil pipeline was temporarily closed after the drone incident. It is a 1,200 mile oil artery the Saudis built to bypass the Straits of Hormuz during the Iran-Iraq war.

Croft said the presence of the U.S. Fifth Fleet in Bahrain would likely discourage Iran from trying to close the Straits of Hormuz, though it could could use its proxies and stage one-off attacks on ships.

“It is important to note that these are not the only flash points in the region, and while an off-ramp may yet emerge, the hawks appear in ascendancy, which leaves oil’s risk premium set to take center stage,” she noted.

Croft said while the Trump administration has not blamed Iran in the attacks this week, they are “under a very heavy cloud of suspicion and there is growing concern that the region’s long simmering cold war may be poised to become a hot one.”

John Kilduff of Again Capital, said that scenario is one side of the tug of war on oil prices.

“The battle in the oil market is the geopolitical premium versus the slowing global economy, which is the fallout from the trade war,” said John Kilduff of Again Capital “WTI would be pressing $70, and Brent would probably push on $80 to $85.” Brent futures were just under $72 per barrel.

But those prices have not moved much higher in last few weeks, even as it became clear the U.S. would play hardball with Iran and pressure its oil sales to zero. It’s been a year since the U.S. dropped out of the agreement between Iran and six nations, which prohibited Iran from working on its nuclear program in exchange for a lifting of sanctions. The U.S. is the only nation to break from the agreement.

Iran has threatened to restart elements of its nuclear program, unless the European signatories of the accord help allow it to make oil sales.

“Historically, with this kind of tension in the Gulf, there would definitely be a security premium in the price. We haven’t seen it this time—so far,” said Daniel Yergin, vice chairman of IHS Markit. “The two big reasons are the trade war, and its potential effect on economic activity and the huge growth in U.S. supply.”

Yergin said U.S. Secretary of State Mike Pompeo has made it clear when speaking to oil industry leaders that the boom in U.S. oil production has helped give the U.S. flexibility.

“This is a case study of how the growth in shale, and the change in the U.S. position affects perceptions about security,” said Yergin. In the past year, the U.S. has surged past Russia to be the world’s largest oil producer. Last week, U.S. oil production was at 12.1 million barrels a day, while exports surged to 3.3 million barrels a day.

“You have this firewall of U.S. output,” said Kilduff. “The Saudis can really turn the spigot on at will. There’s a lot of cushion as we go into this situation with Iran.” Saudi Arabia and OPEC, have been attempting to keep the oil market in balance under an agreement with Russia and other non-OPEC producers. The joint monitoring committee for that group meets this week.

“There was chatter in the market that this weekend, they could agree to raise the production cap to respond to the loss of Iranian crude,” he said. Analyst said Iran exports have already fallen below 1 million barrels a day and it could drop more, to as little as 200,000 barrels a day.

Analysts say the potential for more incidents in the Gulf is increasing, as Iran gets more desperate and its economy gets weaker under U.S. sanctions.

President Donald Trump this week denied reports that the U.S. was considering sending as many 120,000 troops to the Middle East to deal with Iran. But he added if troops were necessary, he’d send “a hell of a lot more.” Trump’s advisers, however, are seen as more hawkish than the president, and it was his national security adviser John Bolton, former U.N. Ambassador, who advised President George W. Bush in the war against Iraq.

“It’s a flammable situation and with lots of room for miscues and miscalculations,” said Yergin.

Blanch said Iran has several options, including dropping out of the nuclear agreement, but the most likely is that Iran will take indirect actions through proxies.

“There’s no sense they’re going to come back to the negotiating table,” said Blanch. “Iran could see being more proactive against U.S. aggression, for the home audience. At the end of the day, the loss of market share for Iran is a gain for the rest of the region. Other than letting others pocket money for the barrels you no longer can sell, you could target those barrels and maybe in the process push the price up and put some pressure on the Trump administration which doesn’t want to see higher gasoline prices. It’s a fine line to walk.”

Kilduff said the market is more on edge, even if prices aren’t rising.

“Because of the maximum pressure campaign the U.S. is putting on Iran, there’s little doubt the Iranians will try to act out through proxies in the areas. We’re tripping into conflict. That’s the sense in the market,” said Kilduff.



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Three options strategies for the week: May 20, 2019

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The “Options Action” traders share three options trading strategies to kick off the week.

Carter Worth and Mike Khouw looked at a put spread in Home Depot.

Dan Nathan illustrated call buying in Ford

Mike Khouw also broke down call selling in Uber



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Trade war may be losing its power to frighten resilient stock market

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The stock market has so far withstood its ongoing “gut check,” with a three-day bounce after last Monday’s mini-tariff-panic sell-off, preserving its longer-term uptrend and leaving the S&P 500 about 3% from its recent record highs.

Still, for a market so close to all-time heights, its resilience to date owes a lot to cautious, risk-evading behavior rather than optimistic conviction about the future.

Stocks have been supported to a significant degree by compressed Treasury yields, which themselves embed high market-implied odds of a Federal Reserve interest-rate cut within months. Such a move by the central bank would come about only in response to waning economic momentum and a rollover in inflation trends.

Here, Bespoke Investment Group illustrates the way the S&P 500 has lately failed to follow 10-year Treasury yields down after tracking them fairly well for a while.

There’s nothing ironclad about the interplay of equities and bond yields — the relationship shifts across market phases. But this at least shows stocks have found a way to hang above the 2,800 zone — once viewed as the ceiling of a sloppy, treacherous trading range — as Treasury yields have succumbed to a global risk-aversion impulse.

What are investors betting on?

One way the S&P has managed this is to lean heavily on more stable, less cyclical stocks. This means turning back toward the familiar favorites of FANG — those organically growing, software-powered giants with fewer bets on China and less sensitivity to macro headwinds.

The FirstTrust Dow Jones Internet ETF (FDN), a good proxy for FANG-type stocks, is up 21% this year to 14% for the S&P 500. The iShares Software ETF (IGV) is ahead by 24% for 2019. Since the day exactly two months ago when the 10-year Treasury broke down below 2.6% toward its current 2.39% level, IGV is up 2.9% to the S&P’s 1.2% gain.

Another popular hiding place is “low-volatility” stocks — stable companies’ slower-moving shares, which act somewhat like bonds. Here’s the Invesco S&P Low-Volatility ETF (SPLV, in red) against the S&P 500 (green) and the Invesco S&P High-Beta ETF (SPHB, blue) over the past month. In other words, the stock market has been held up by stocks that behave less like stocks than most stocks.

Aside from sector divergences, the small-cap Russell 2000 continues to underperform badly, while the rise in risk-aversion can also be seen in the Japanese yen and Swiss franc moving higher in recent weeks.

In a way, the strength in steadier, blue-chip U.S. stocks is not inconsistent with sinking global bond yields and gains in safe-haven currencies. On some level, large-cap American equities are on the same “relatively expensive but higher quality” end of the asset spectrum.

Risk-shunning attitude

The tariff escalation could easily be viewed mostly as an excuse for a standard shakeout after a 25% rally since December, just in time to keep complacent investor sentiment and positioning from stretching all the way to extreme and self-undermining overconfidence.

Two choppy, headline-tossed weeks for stocks have gone some distance toward moderating gathering mood, with a risk-shunning attitude evident in investor surveys and fund flows.

While a bit fickle and narrowly sampled, the weekly American Association of Individual Investors poll showed one of the eight largest jumps in bearish respondents in a decade, with more bears than bulls.

This is echoed by significant drops in optimism in professional-investor sentiment gauges kept by Consensus Inc. and Market Vane toward neutral readings from multimonth highs just two weeks ago.

Outflows from equity mutual and exchange-traded funds has been more the rule than not this year, suggesting the fourth-quarter collapse in stocks has had a lasting effect on investor attitudes.

Ned Davis Research shows this heavy pace of withdrawals against the S&P 500, which goes down as a bullish factor from a contrarian perspective.

The latest flare-up in trade friction with China has rubbed a raw nerve among investors, who explained stocks’ steady climb through April as a story of big threats fading from view: The onrushing recession feared in December is not in evidence; the Fed has backed away from rate hike plans; corporate earnings arrived better than forecast; and, until two weeks ago, the U.S.-China trade tussle looked near a benign resolution.

After last Monday’s 2.5% sell-off, stocks showed signs of again trying to set aside the trade issue, which — for all its drama over the past two years and the high perceived stakes — has not been able to hold the market hostage for long stretches of time.

The bounce that started Tuesday allowed the S&P to narrow its weekly loss to 0.8%. On a net basis, the market was up during regular trading hours, with overnight weakness dropping the indexes at the open, only to have buyers pick them up in the regular session.

The makeup of the rebound was not all that impressive, granted. Market breadth continues to lag a bit, with fewer than half of all S&P 500 stocks in a technical uptrend, to cite one soft spot.

(It was the fourth straight negative week for the Dow, and there have not been five straight down weeks for the index since the 2011 minibear market, so the odds hint at some short-term relief.)

The market continues to track the 2016 path, in broad terms: a brutal minibear market gives way to a more dovish Fed and huge stock market rebound even as bond yields stay low, defensive stocks lead and investor sentiment stays muted.

Several months after the early-2016 market bottom, the Brexit vote shock administered a stiff and scary test, proving good enough for only a sharp, brief sell-off before stocks resumed an upward grind. Could the trade-war scare of May prove a similar geopolitical test that doesn’t get “resolved” but loses its power to frighten investors so readily?

This is a notion investors need to ponder but the market will have to prove or refute.



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Hotshot active fund managers will soon have a way to play the ETF game

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Pedestrians walk past the New York Stock Exchange before the closing bell in New York.

Bryan R. Smith | AFP | Getty Images

A new kind of exchange-traded fund is expected to grant active money managers a way to offer their strategies without divulging their stock picks and methods, a key hang-up that’s kept them from participating in the booming industry.

ActiveShares, a product designed and built by Precidian Investments, received word from the Securities and Exchange Commission on April 8 that its so-called nontransparent ETF model should be approved.

Nontransparent ETFs would mask the underlying securities of the fund but still allow investors exposure to the portfolios arranged by Wall Street’s top stock pickers. Industry analysts also anticipate the funds will reduce key fund expenses and grant tax advantages — just like other ETFs.

Though Precidian is still awaiting a final order from the SEC, founding principal Stuart Thomas told CNBC the product is the first of its kind and could someday impact the entire mutual fund industry.

“At the end of the day, it looks, smells and feels like an ETF because it is an ETF,” Thomas said. “You’re taking actual slices of the portfolio — anytime there’s a creation or redemption in their appropriate weightings — and that’s what the authorized participant is delivering to the fund in exchange for ETF shares.”

“There’s nothing complicated, it fits perfectly within the ecosystem,” Thomas said of the ActiveShares model. “Trading, settling, reporting, monitoring: All the existing strategies the trading desks use today can be applied to this structure.”

ActiveShares could represent a big opportunity for a generation of active managers that have seen their assets evaporate at the hands of low-cost, passive alternatives drawing in big investor dollars.

At the end of April, passive U.S. equity fund assets reached parity with active U.S. equity funds at $4.3 trillion each, nearly 13 years after actively managed U.S. equity funds saw their last calendar year of net inflows and amid one of the longest bull markets ever, according to Morningstar Direct research.

But the new nontransparent funds could offer a way to recapture investor dollars, says J.P. Morgan analyst Kenneth Worthington.

“Precidian’s non-transparent ETF is a potentially crucial structure in the evolution of the actively managed mutual fund industry, as it holds the potential to deliver greater tax efficiency and meaningfully lower costs to fund investors,” Worthington told clients in a note Thursday.

‘Levels the playing field’

Part of the reason ETFs are so popular is their tax advantages compared with the traditional mutual fund model.

As long as the index an ETF tracks doesn’t see frequent changes to its composition, the funds themselves rarely have to adjust their portfolio to match. Also, when market makers redeem ETF shares, they receive securities instead of cash, further shrinking the need for the fund to declare gains.

“We see retail investors as long-term beneficiaries, and exchanges and trading firms stocks as being helped,” the analyst wrote. “We also think the structure levels the playing field somewhat between passive and active investing.”

“Potential linkages of ETFs and mutual funds could enhance the tax profile of existing mutual funds, making the products ‘must-haves’ for mutual fund companies,” he added.

Worthington sees T. Rowe Price in particular as a potential beneficiary of the new structure. Given its its size and relative success over the long term, the analyst said, it may be able to attract money from the passive side if it adopts such a model. The mutual fund manager has applied for a similar ETF structure with the SEC.

“We believe the Precidian approval is good news for those, including us, with proposals for semi-transparent ETFs in front of the SEC, and for investors,” T. Rowe told CNBC in an emailed statement. “We have more work to do to get our application through the SEC, and our ongoing conversations with the SEC staff continue to be constructive.”

Precidian’s Thomas has a history of innovating in the fund world. A Morgan Stanley and Merrill Lynch alum, he started World Gold Trust Services in August 2002. At the direction of the World Gold Council, he created, managed, and marketed the first U.S. commodity-backed equity traded on an exchange.

That ultimately evolved into SPDRGold Trust, the first U.S. traded gold ETF and the first U.S.-listed ETF backed by a physical asset. The Precidian team, which includes Daniel McCabe, Mark Criscitello and Paul Kuhnle, is also responsible for building the first currency-backed ETFs in the U.S. with Rydex. That platform is now owned by Invesco under its CurrencyShares suite.



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