What should investors do about rising oil prices?

The situation in the Middle East is moving very quickly and like any geopolitical event, it’s difficult to anticipate where it’ll go next.

US crude oil prices surged 35.6 per cent last week following the first US strikes, which saw them finish at over US$90 a barrel.

At the beginning of this week, prices jumped again, hitting US$100.

That was the highest since 2022 when the Russia/Ukraine war started, and during the Arab Spring period in the early 2010s.

The Strait of Hormuz has been the biggest concern, as some 20 per cent of global oil ships move through this chokepoint.

It’s been closed due to the cancellation of insurance policies and the likelihood of attacks, which means fuel can’t get to its destination.

That’s seen production cut back in places, as there’s no point producing something you can’t ship to a customer.

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With oil prices at elevated levels and the challenge in predicting when things will ease up, markets are nervous.

Investors are starting to consider the impact on inflation, central bank policy settings, and economic growth.

Oil prices flow through to just about everything, adding to input costs which inevitably get passed on to consumers.

That puts central banks in an awkward position, as they have an obligation to respond to the rising cost pressures despite the obvious downside risks to growth.

We’ve already seen wholesale interest rates increase on the back of this, as investors reconsider the next move from policymakers.

Next week will be fascinating, with the US Federal Reserve, European Central Bank and the Reserve Bank of Australia also scheduled to announce monetary policy decisions.

Markets have pared back expectations for rate cuts in the US this year, while they’ve moved to price at least one hike in Europe.

The Australian central bank has already been forced to raise interest rates once this year, and it might have to do more in the months ahead.

Our own Reserve Bank meets next month, and while it is firmly on hold the Governor will need to walk a communication tightrope.

Higher fuel costs and potentially tighter monetary policy are headwinds to economic growth, which is why you’re seeing global sharemarkets sell off.

The US is holding up best, which makes sense given its scale and strength.

Investors always flock to safety during volatile periods, while the US dollar (which remains the world’s reserve currency) is attracting some flows too.

The US is also in a strong position in terms of its energy supply, having been a net total energy exporter since 2019.

It still imports oil, but imports have been steadily declining for 20 years and its oil import dependency remains relatively low.

Domestic shale production has been healthy in recent years, and Canada is the dominant supplier of imported oil.

In contrast, China, India and Japan are big consumers of oil transported through the Strait of Hormuz, making them more vulnerable to ongoing disruption.

For investors, it’s difficult to know how to react.

If we panic and start selling now, we run the risk of missing any recovery should the conflict subside.

Nobody knows when or how that might happen, but markets could rebound strongly if the tensions subside.

If things worsen, the types of assets that are likely to hold up best are government bonds and high-quality fixed income.

These provide predictable income, and should exhibit minimal volatility as long as they aren’t of lengthy duration.

Cash is obviously very stable, although only on a short-term basis as it offers little inflation protection.

Gold often performs well during crises or wars, while energy, defence and commodity exposures will be benefitting from the backdrop right now.

Some companies in the materials and industrials sectors could also benefit, while those sensitive to consumer demand will suffer if oil prices remain high and pressure household incomes.

The situation is highly unpredictable, and none of us know where it will go next with confidence. While it’s tempting to make drastic changes, history suggests geopolitical conflicts tend to be short-lived disruptions, rather than long-term events that derail your investment strategy.

My best advice would be to stay calm and ensure you’re well-diversified.

Instead of making wholesale changes, talk to your adviser about opportunities to tilt your portfolio in a slightly more all-weather direction.

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