War Sets Off Market Nerves

By Alexander Taylor

When the shooting started, gold and oil prices rose and stocks slumped

Ever since the oil embargo of 1973, Western economies have had to live with the fear that precious crude from the Middle East would once again be cut off. Last week, as the war between Iran and Iraq threatened to make that bad dream a reality, financial centers from New York to Tokyo immediately trembled. But the markets then responded with surprising strength and absence of panic. Said one Manhattan stockbroker at midweek: "The market seems to be taking this as if nothing were happening. It seemed that the latest Middle East war was one the Western oil-consuming world could still afford, at least for the moment."

The relative steadiness in financial markets was based on a widespread belief that the fighting in the Persian Gulf would be of limited duration and would not seriously interrupt or reduce the petroleum flow. The world currently has a comfortable 2 million to 3 million bbl. per day oil-production surplus, and in the short run, other OPEC nations could make up the loss of crude exported by Iran and Iraq.

Nonetheless some oil experts warned that the 100-day supply of crude around the world could quickly evaporate. Two years ago, there was also an international oil glut, but that was quickly gone after the upheavals in Iran resulted in lower production in that country. Much of the so-called glut is oil needed to fill the complex transportation and refining network, and a decline of as little as 7% could touch off emergencies.

Data Resources, the Lexington, Mass.-based econometric forecasting firm, estimated last week that an extended shutdown of the 4.9 million bbl. per day production in Iran and Iraq could cause a rise in world oil prices of 50% above its original projections by the end of 1981. Since petroleum prices are extremely sensitive to any long-term reduction in world oil supplies, a shortfall in Iranian and Iraqi crude could hike the contract cost of a barrel of oil from its current $32 to about $57.

Gold, the international barometer of world economic anxiety, quickly reflected last week's heightened concerns. In just two days, the yellow metal's price shot up to $720 per oz. in London, an increase of $46. Later in the week, however, the price slipped back to around $700 per oz. Those levels are still well below the alltime high of $875, which was reached in January after the Soviet invasion of Afghanistan. Gold shares on the Johannesburg stock exchange in South Africa, where most of the Western world's gold is mined, were heavily traded. Reported one broker: "The Americans are grabbing everything they can get." Frightened Arab bullionaires are now asking for physical possession of their precious metal rather than leaving it in Swiss or other bank vaults. Reason: after the American seizure of Iranian financial assets in June, wealthy Arabs became leery about leaving their property in any Western banks. Since August, more than 150 tons of gold have been repatriated from European banks to Kuwait and Saudi Arabia.

The outbreak of fighting immediately drove up prices of oil purchased on the spot market; oil brokers predicted that prices for long-term supply contracts might soon follow. The spot market reacts quickly to international tensions because it is composed of prices set by traders who usually buy and sell small shipments of crude. Spot oil in Rotterdam rose from $31 to $33 per bbl. last week and very little of it was available. Said one trader: "Everyone believes that Brazil, France and Italy will have to go on the spot market to make up for oil missing from Iraq and Iran. Anybody who has spot oil is asking as much for it as possible."

Higher oil prices could raise the projected U.S. inflation rate in 1981 from 9.8% to 13%, according to Data Resources. That is a discouraging prospect for American consumers, who last week were told by the Bureau of Labor statistics that food prices in the U.S. rose 1.7% in August, the highest increase in 2 1/2 years. Although fuel costs did not increase at all in August, the Consumer Price Index jumped 0.7%. The Federal Reserve moved late in the week to attack inflation by raising the discount rate, the fee it charges on loans to member banks, from 10% to 11%. In response, banks began pushing up the prune rate to 13%.

World currency markets were relatively calm last week. The dollar and the British pound were the strongest of the principal currencies. The strength of the pound was due to Britain's plentiful North Sea oil deposits, which will be worth even more if petroleum prices again increase. It is also kept robust by the country's 16% interest rates. British exporters, however, complain that their goods are now overpriced in foreign markets in comparison with products priced in weaker currencies. The dollar was robust largely because it remains, despite U.S. economic problems, the world's "refuge currency." Nervous speculators who cannot acquire gold traditionally turn to dollars at times of extreme world tension.

The possibility of a world petroleum shortage was enough to cause a temporary bull market for oil companies that enjoy extensive reserves outside the Middle East. Many oil stocks on the New York Stock Exchange last week rolled to new yearly highs. Among them: Amerada Hess, Atlantic Richfield, Kerr-McGee, Shell, Standard Oil Co. of Indiana and Standard Oil Co. of Ohio.

The rest of the New York Stock Exchange, though, had its own case of war jitters. Last Monday, before the full dimension of the Iran-Iraq conflict was clear, the Dow Jones industrial average hit a 44-month high of 974.57. It was mostly downhill after that. By Friday, the Dow Jones had lost 34.47 points and closed the week at 940.10. Declining issues led advancing stocks by a wide margin. Insiders watch the advance-decline ratio closely because it often signals future market trends. Especially hard hit were airlines, whose profits are particularly sensitive to high fuel prices. Brokers said that the Federal Reserve's higher interest rate was as much a cause of the market drop as war fears. "A lot of people here were amazed at how well the market has held up in this crisis," said Anthony Estep of Salomon Brothers. Barring a calamitous widening of the war that would cut off all oil from the Persian Gulf, the long-running Wall Street bull market could easily resume.

Since April the Dow Jones industrial average has risen over 180 points. Leading the bulls have been trendy new issues. So far this year, 120 companies have gone public, compared with 81 in all of 1979. Investors have been snatching up hot new stocks in such fashionable areas as high technology, medical engineering and energy. Applicon, a Burlington, Mass., computer design concern, went public in July at $22 and is now trading for more than $40 per share. Shares of Energy Clinic, which evaluates business energy consumption and recommends conservation measures, are selling at more than double their $1 July offering price.

Professional stock buyers are now waiting with checkbook in hand for two new companies that will soon go public. They are: Genentech, one of the world's leading laboratories involved in DNA research and gene splicing, and Apple Computer, the darling of the home computer industry. The Apple issue is so hot that virtually none of the initial stock will be available to the public. The shares have already been promised to favored customers of Morgan Stanley & Co., which is one of the underwriters for the offering.

Despite the sanguine initial reactions to the war on Wall Street, in international currency trading and among oil experts, Iraq at the end of the week took a step that could undermine that prognosis. Baghdad, which is OPEC's second largest exporter, announced that it was suspending all foreign shipments of oil--including the crude that is pipelined to Mediterranean ports. That move alone was enough to revive the embargo nightmare of 1973, which sent the world economy into a tailspin from which it has never completely recovered. Observed Robert H. Parks, a Wall Street institutional in vestment counselor: "The military conflict between Iran and Iraq reminds us of just how vulnerable the world economy is to a new bout of inflation or to a cutoff of oil supplies."

--By Alexander Taylor. Reported by Frederick Ungehauer/ New York and Bruce van Voorst/Brussels

With reporting by Frederick Ungeheuer, BRUCE VAN VOORST

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