Guggenheim's Scott Minerd On The Surprising Winner From The Upcoming Domino Collapse

by Tyler Durden
03/01/2011 14:08 -0500

Guggenheim's Scott Minerd has released a somewhat controversial piece looking at several steps forward in case the MENA crisis escalates to the point where dominoes start toppling each other. His conclusion: "After all these dominoes fall, global investors will likely find themselves in a world that looks like this: the Middle East is highly unstable, emerging market economies are slowing, and the crisis in Europe has been exasperated by shrinking exports, leading to a decline in the value of the euro. Against this landscape, the U.S. economy and dollar-denominated financial assets will look increasingly attractive on a relative value basis." Needless to say we disagree with this rather simplistic assessment, or rather, with a very large caveat: in nominal terms, Minerd may well be right, but the resultant surge in oil to well over $200 (should his thesis pan out) will cripple the US economy, force the Treasury to turn on the afterburner on debt issuance, and ultimately result in the biggest bout of monetization ever, resulting in the death of the US dollar (and thus, the resurgence of the gold standard). That said, it is a good piece, if one takes the conclusion with a big piece of salt. In our opinion, the only clear winners from the domino collapse will be oil as we have claimed since early January... and the PM complex of course.

The Economic Domino Effect, by Scott Minerd of Guggenheim Partners

The democratic movement erupting across the Middle East and North Africa (MENA) reminds me of the historic political changes that occurred the early 1990s when the Berlin Wall fell, the Cold War ended, and a series of revolutionary events led to the dissolution of the Soviet Empire.

When the populist revolution broke out in Egypt, I happened to be in Moscow speaking at the Troika Dialog Russia Forum. I must admit, being at the scene of the Russian revolution 20 years later made the events transpiring in Egypt feel all the more historic. One morning I watched images of Egyptian protestors standing on tanks in Tahrir square in Cairo, and at a dinner that evening I listened to first-hand accounts of when Boris Yeltzin stood on a tank outside the Russian White House during the 1991 revolution.

While my Russian colleagues recounted the winds of change that brought the collapse of communist regimes in the early 1990s, I could not help but reflect on how the political transformations of that period also precipitated turmoil in the financial markets and severe recessions.

The unification of Germany in late 1990, for instance, led to the European currency crisis in 1992-1993 and essentially plunged the entire continent into a deep recession.

This crisis was a particularly vivid experience for me because at the time I was running European fixed-income trading for Morgan Stanley. Similarly, the 1991 collapse of the Soviet Union was followed by a severe recession and hyperinflation.

History teaches us that the revolutionary road is lined by economic shocks and currency instability. As the events play out in the Middle East and North Africa, I believe the turmoil in the region will perpetuate an economic domino effect that may result in dramatic shifts across the investment landscape over the course of the next year.

The Global Cost of Turmoil: Higher Oil Prices

As we have already begun to see, the mere threat of a disruption to the world’s oil supply has caused the price of crude oil to spike. The extent and duration of the spike in oil prices will depend largely on whether the threat extends beyond smaller oil producers like Libya, Algeria, Yemen, and Bahrain, and into larger players like Saudi Arabia and Iran. Keep in mind that oil prices spiked 15 percent on the perceived threat that Libya’s production of 1.6 million barrels per day might be in jeopardy. Imagine what may happen to prices if investors perceive the possibility of an interruption to Iran’s production of 3.7 million barrels per day, or Saudi Arabia’s 8.6 million barrels per day.

In terms of how high crude oil prices may rise, the summer of 1990 may provide some perspective. During the early stages of Operation Desert Storm, crude oil prices rose 141 percent over a three-month span. It was another five months before prices returned to pre-crisis levels, which meant that for more than eight months oil prices were, on average, 40 percent higher than pre-crisis levels.



If we apply a price appreciation experience similar to the Gulf War in 1990 to the average crude oil price one month prior to the protests in Egypt (approximately $90 per barrel for sweet crude oil futures on the NYMEX), we arrive at oil reaching as much as $215 per barrel. If we apply a lower percent increase, say the average increase of 40 percent during the 1990 conflict, crude oil would still exceed $125 per barrel. With crude oil futures currently trading around $98 per barrel, this means it would be possible to see oil prices rise another 25 percent increase from present levels.

Short of a threat to Iran or Saudi Arabia, oil at $200 per barrel is unlikely; however, as the democracy movement spreads across the MENA region, I believe there is a very real prospect that crude oil prices could hit $125 or higher.

Higher Energy Prices Mean Pressure on Emerging Markets

If energy prices linger at such elevated levels, the next domino will be heightened inflationary pressures around the world, but particularly in the emerging markets. Central bankers in Brazil, Russia, India, and China (the “BRICâ€