We thought we should begin 2024 where we ended 2023:

Namely, worrying about the escalation of conflict in Middle East.

We touched on this a few times in the horrible weeks after the October 7th attack in Israel and have mentioned in passing and explicitly just how dangerous the situation is becoming.

You can read our most recent previous work here.

The concern was that the already brutal war in Gaza and Israel could spread to either Lebanon or elsewhere and this could quickly drag in the United States and eventually spark a larger conflict with Iran.

Unfortunately, in the intervening weeks since then those fears have leapt off the page and become a real and enduring threat that is having an impact far beyond the Middle East.

How so?

In practical terms, the Houthis, an Iranian-backed political movement that controls a significant portion of Yemen has begun serially attacking shipping passing through the Red Sea near Yemen on its way to the Suez Canal.

You can all the individual attacks here and you will quickly realize that these are neither minor threats nor sporadic.

Here is a rough map of November and December’s attacks:

We should also tip our hat to the sailors on these ships. It takes a particular type of bravery or insanity to ride on a tanker full of liquid natural gas while being targeted with radar guided missiles.

These unprovoked strikes have had all sorts of swift knock on effects:

The most basic is that, surprise, surprise, many shipping firms are now rerouting their cargo around the Cape of Good Hope.

The second is that the West has responded with a task force of its own. Aside from its very amusing name, the arrival of Task Force "Prosperity Guardian" means that there are now Western military assets in the same theater as Iran's least reliable proxies.

And finally, it is becoming clear that Iran isn't just content to remain in the shadows providing intelligence and munitions to their Houthis allies. Instead they are becoming increasingly active on the ground helping direct and ratchet up the violence and chaos.

What are the implications here? How should we think of all this?

Well the most obvious point is that this will have an immediate and serious effect on global shipping.

This hasn't been insignificant either. Global giants like Maersk, Hapag-Lloyd, MSC and Evergreen have re-routed all shipping away from the Suez Canal and many smaller firms are now doing likewise. ​

(there is an interesting sidebar which we may return to where global shipping firms may profit from this situation)

The arrival of the task force should help but it may be many months of calm before large multinational shipping firms - to say nothing of their sailors! - feel confident enough to send the majority of their traffic through the Red Sea.

Here is what this currently looked as of January 4th:

Each dot is the transponder of a ship at its present location. This map tells a stunning tale: 95% of Red Sea shipping is now taking an alternative route.

The outcome is simple. As a direct result of this aggression most goods are going "the long way" which adds about 10-14 days, 4000 miles and 25% to shipping costs and we will likely see costs head higher still as fears about global shipping send rates, insurance and other costs higher still.

It should also be noted that this only seems to apply to Western shipping firms. Thus far, Chinese (or Russian etc.) firms seem to be somehow immune from the Houthis' wrath. Furthermore, China hasn't joined the Prosperity Guardian Task Force either.​

There are some interesting economic as well as strategic implications to consider here.....

Such as: if you were, say, an Indian exporter or a Singaporean shipping broker or an Indonesian palm oil company, who would you use to ship your goods?

The main concern is that, almost as if by design, the arrival of the US-led task force to the Red Sea brings the next stage of escalation into view. Now that you have Western naval forces in the vicinity the question suddenly becomes: when will they be targeted by the Houthis and when that inevitability occurs, what then?

It is important to mention that the Houthis aren't a newer, Arab-version of the Somali pirates of yesteryear either. Thanks largely to their Iranian backers they have modern helicopters, missiles, radar, and, perhaps most dangerously, training and intelligence from Iranian special forces. This may not make them the equivalent of a Western strike group but it might make them crazy enough to try to take one on.

Thus, the likelihood of an incendiary "incident" between the West and, by everyone's agreement, a volatile and unpredictable Iranian-ally is now not just possible but very probable.

If you were watching this movie in theaters you might find this all a bit far fetched but slowly and regrettably, the pieces are falling into places for something else in the region to go "boom."

Lastly, you now have a situation where Iranian and US and other Western countries military assets are now in the same waters. This was always pretty true from one perspective. It isn't as if the Republican Guard and its spies are not all over Syria, Lebanon and elsewhere around the Middle East already.

However, now they are operating ships and aircraft in the same Red Sea water and air. It is a very small step - though a substantial one - from there to outright war. Missed signals, crossed wires, misread intentions or one commander with a bit too much cowboy in him (and it will be a "him" almost certainly) and Tom Clancy's Admiral Painter will be back in fashion:

Practically, what can you do about all of this?

Aside from "this is bad" and likely getting worse the implications are actually a bit thorny.

The most obvious play might be to consider buying oil or energy more broadly in case something really erupts and global energy flows are severely disrupted.

We aren't so sure.

It is very possible that there could be a classic oil shock if war were to spread but - for now - the Red Sea issues and the current brutal conflict in Israel and Palestine aren't a direct threat to global oil supplies. This should remain the case even if the Task Force begins to answer aggression with aggresion.

That could change!

The big worry to watch out for is an increase in Iranian and US conflict and especially in the Persian Gulf and around the Strait of Hormuz. The latter is only around 20 miles wide at its narrowest point and full of islands controlled by Iran. Around 20% of global oil supplies pass through the bottleneck but a good chunk of that belongs to Iran itself.

The Strait has been closed twice in the modern era: once in 1973 during the initial oil shock and again during 1979 during the height of the Iranian Revolution. For reference, each time oil rose 300%+.

But also important to remember that circumstances have changed since then. The US produces a lot more oil than it did in the 1970s for one and OPEC isn't as united or as influential for two. So, we could reasonably expect that the impact this time around might be very significant but not quite as extreme.

Thankfully, however, the Strait of Hormuz is not yet in play. At least for now. And it is for that reason we still think that, despite the awful headlines, the Middle East is a risk to watch rather than a risk to address for most investors.

That isn't very satisfactory, we realize, but "pay close attention to developments" might be simply the best course of action for now.

The cleanest way to express being concerned about the Middle East and what is going on there might be to slowly rotate away from equities and towards bonds - or at least bond proxies, see next story - as the weeks and months pass.

There are other reasons we like that strategy - possible faltering growth for one - but the longer conflict(s) continue, the greater the risk of something going very wrong and expanding the conflict in terms of geography, participants and brutality.

The Houthis aren't the only type of proxy that is interesting in early 2024 either....

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