Eastern dragon threatens to bite

IF YOU think that the world’s financial ills have all been resolved, think again. Lingering geopolitical tensions in the east have the potential to shake markets, and could sting traders if they are not positioned appropriately.

Today marks the anniversary of the invasion of Manchuria, when Japanese forces invaded a northern region of China in 1931. And tensions have recently been stoked further between the two largest Asian economies over the sovereignty of a group of islands in the East China Sea, said to be rich in natural gas.

Chinese state media has warned that trade relations between the two countries are in jeopardy. David White of Spredex points out that “with £215bn trade between the two countries this is a worry. But sentiment may overshoot material impact”.

The news will be unwelcome to Japanese companies who trade with China. Toyota, whose cars have been targeted in a wave of anti-Japanese sentiment, sold 895,000 units in China last year, representing about 11 per cent of their sold units. It also built around 800,000 units in China. Its shares would be affected should the situation escalate.

Christopher Beauchamp, market analyst at IG Group thinks “increased tensions could undermine regional confidence,” resulting in a flight out of Japanese yen and Asian equity indices. He believes it would not be farfetched to see a flight into safe havens such as US treasuries, as well as oil.

On the back of tensions with Israel and the US, Iran has threatened to close the Straits of Hormuz, a 40km stretch through which 20 per cent of the world’s oil supply passes.

White says that QE3, coupled with geopolitical tensions in Iran, could work together for traders: “Devaluing the dollar has an impact on dollardenominated assets like oil, which seems positioned to rise.” Beauchamp thinks “Iran is loath to actually close the Straits – it would affect their oil revenues too,” but if the situation deteriorates, closing the Straits would be like “throwing a match onto the oil market”.

White suggests that there are other potential plays, such as large-cap oil and gas companies, like Chevron and BP: “Both are relatively depressed in earnings multiples and could see upside benefit.” Beauchamp adds that “there could be a negative knock-on impact on the mining sector,” as well.

Traders should be cautious with contrarian plays like this until the situation becomes more clear. As White advises: “Trade what you see, not what you want to see.”