Gold and Crude Oil Surge Amid Middle East Tensions as Markets Weigh Potential Escalation

Following Israel’s initial strike on Iran earlier this month, global markets have thus far responded with restraint. The S&P 500 Index remains approximately 3% below its February peak, even after modest declines over the past two weeks. Since Israel’s June 13 attack, Bloomberg’s U.S. dollar index has risen by less than 1%.

This tempered reaction reflects investor expectations that the conflict will remain localized and not disrupt broader global economic conditions. However, analysts warn that volatility could increase significantly should Iran escalate tensions by targeting U.S. military forces or obstructing key oil and gas shipping routes such as the Strait of Hormuz.

Evgenia Molotova, Senior Investment Manager at Pictet Asset Management, noted that markets are closely monitoring developments: “Only if the Strait of Hormuz is blocked will markets respond seriously, as such an event would directly impact global oil transport.”

Iran has vowed lasting consequences for those responsible for the attacks and affirmed its right to defend its sovereignty. Meanwhile, Israel has resumed strikes on Tehran and military facilities in western Iran. Charu Chanana, Chief Investment Strategist at Saxo Markets in Singapore, observed: “This marks a turning point in the markets. The key question is whether U.S. assets will continue to enjoy safe-haven premiums.”

Despite this, downside risk appears limited as investors have already positioned for a potential escalation. Since mid-June, the MSCI World Index has declined by 1.5%. Fund managers have trimmed equity holdings, valuations are no longer stretched, and hedging activity has increased, all of which reduce the likelihood of a significant selloff.

Morgan Stanley oil analysts stated that a rapid de-escalation could bring crude prices down to around USD 60 per barrel. However, if tensions persist, oil may trade within the current elevated range. A substantial disruption to global supply or a hit to transit in the region would likely push prices significantly higher.

The firm also noted that continued oil price increases could trigger a short squeeze in the U.S. dollar. Although fundamentals suggest the dollar’s strength may be waning, recent U.S. fiscal and trade policies have already weakened it. Neil Birrell, Chief Investment Officer at Premier Miton Investors, described shorting the dollar as “the biggest trade right now.”

Sebastian Boyd, a strategist at Bloomberg, said the dollar could gain traction if it breaks from the bearish consensus in place since early April. However, he cautioned that if the rally proves to be a fleeting reaction to U.S. involvement in the Middle East, the dollar could quickly resume its downward trend.

Emmanuel Cau, Head of European Equity Strategy at Barclays, remarked that markets may focus in the near term on Iranian retaliation, particularly regarding the risk of closing the Strait of Hormuz. He added that although oil shocks tend to be short-lived in equity markets, they often present medium-term buying opportunities. A more stable and peaceful Middle East could ultimately benefit risk assets.

Anthony Benichou, from Liquidnet Alpha’s cross-asset sales division, highlighted political sensitivity in the U.S., especially with oil prices climbing ahead of the midterm elections. A prolonged price spike could stir inflation and voter discontent, making a swift and decisive resolution politically necessary. He also pointed out that while oil markets show clear risk premiums, the effects on other asset classes have been limited. “If Iran closes the Strait of Hormuz, it could be cutting off its own main source of revenue and hastening its own economic collapse,” he warned.

Manish Kabra, Head of U.S. Equity Strategy at Société Générale, believes equity markets might only see a mild dip. Current central bank policies are far more accommodative than during past oil shocks. He stated that the Federal Reserve is unlikely to react strongly to potential oil-driven inflation, maintaining the firm’s view that the S&P 500 Index could still reach new highs this year.

Anthi Tsouvali, a strategist at UBS Global Wealth Management, emphasized that investors should consider the inflationary impact of rising oil prices. She noted that Europe, in particular, could be more vulnerable than the U.S. While this event adds to an already uncertain outlook for 2024, Tsouvali said that volatility may be short-lived given that, to date, energy infrastructure remains intact and the Strait of Hormuz is still open.

Shoki Omori, Chief Strategist at Mizuho Securities, said capital is likely to flow into traditional safe-haven assets such as Japanese government bonds, the yen, the Swiss franc, and gold. He added that U.S. Treasury yields could fall sharply as investors flock to Treasuries, anticipating dovish signals from the Federal Reserve. “Any suggestion of attacks on U.S. territory or troops could drag the dollar down, with USD/JPY potentially falling to 144,” he said.

Nick Twidale, Chief Analyst at AT Global Markets, projected that gold could surge to USD 3,400 amid rising volatility. However, he stressed that the duration of the rally will depend on U.S. policy decisions. “Compared to Tehran, Trump holds more leverage, so whether he escalates further or returns to diplomacy will shape market sentiment,” Twidale explained.

Viraj Patel, strategist at Vanda Research, pointed to the recent U.S. airstrike as another trigger for hedge funds and CTAs to unwind their bearish positions on the dollar. He warned that a renewed dollar rally could become one of the most painful trades of the summer. Patel also observed that non-U.S. equity markets, especially the heavily invested cyclical sectors in Europe and Asia, may face a “perfect storm.” In addition to Trump’s trade tariffs dampening cross-border flows, rising geopolitical tensions are placing further strain on global growth prospects. As investors grow increasingly cautious, inflows into these markets may begin to subside, potentially leading to underperformance in Europe and emerging economies.