Strait Disruption: The Battle Between Metals' "Safe-Haven Selling" and "Supply Shock"

Author: Jian Wei Zhi Zhu Miscellaneous Talks

Last night, I read JPM’s latest weekly metals report, which mainly discusses the game between “risk-off selling” and “supply shocks” faced by major metals amid the disruption of shipping through the Strait of Hormuz.

Key conclusions:

1. Gold: Short-term “mispriced,” long-term bull market

Core contradiction: Safe-haven attribute vs liquidity crisis

In the short term (the “sell everything” mode): Recent gold price declines are not due to a failure of safe-haven status but are driven by market panic (VIX soaring), where investors sell all assets—including gold—to meet margin calls and cash needs. Data shows that when VIX >30 and rising, the weekly probability of gold rising is only 45%, with an average return negative.

Tactical buy point: Historical data indicates such panic selling usually lasts about 10-15 days. Starting from the third day after the sell-off, gold prices often begin a sustained rebound lasting about a week, with an average increase of over 2%.

Long-term logic (bullish turn): If energy disruptions persist, with high inflation combined with recession risks (stagflation), the Fed will be forced to adopt easing policies to maintain employment. This “stagflation + rate cuts” scenario will create an extremely bullish macro environment for gold.

2. Aluminum: The most steadfast long position

Core logic: Supply-driven super bull market

Fragile supply chain: Middle Eastern aluminum smelters heavily depend on imported alumina (raw material) and export finished products. The closure of the Strait of Hormuz cuts off the dual channels of raw material inflow and finished product outflow.

Inevitability of production cuts: Even if some producers (like Qatalum) temporarily operate at 60% capacity, their raw material inventories can only support 30-50 days. If shipping does not resume, large-scale production cut announcements are expected in the coming weeks.

Price target: Supply disruptions will push aluminum prices rapidly above $4,000/ton.

3. Copper and Nickel: High risk but different buffer periods

Shared risk: Disruption of sulfur (S) supply chain.

The Middle East supplies 50% of the world’s shipped sulfur, which is a key raw material for sulfuric acid, essential for wet-process copper (SX-EW) and high-pressure acid leaching (HPAL) nickel production.

• Copper (more pessimistic):

Risk: Production in DRC and other regions may be affected, impacting about 7% of global supply.

Buffer: 4-6 months of inventories and transportation buffers. Before actual shortages occur, markets will likely price in macroeconomic recession expectations, leading to an initial decline in copper prices.

• Nickel (more neutral/bearish):

Risk: 80% of Indonesian HPAL nickel depends on sulfur imports from the Middle East, with only about 1 month of buffer.

Positioning: Impact level between aluminum (most bullish) and copper (more bearish). Costs may surge, but the main current risk remains a sell-off driven by macro sentiment.

1. Gold and Market Pressure—Contagion Risks Before the Rise

In the second week of the Iran conflict, aluminum remains our preferred bullish base metal because we believe that as long as shipping through the Strait of Hormuz remains disrupted, aluminum is approaching a highly bullish, supply-driven critical point.

Copper supply also faces risks from sulfur supply chain disruptions, potentially affecting about 1.8 million tons of cathode copper from DRC, about 7% of global supply. Despite the large volume involved, the relatively long supply chain from sulfur to Congo suggests that before supply shortages become critical, the first risk is a sharp price decline due to macroeconomic reassessment.

Nickel also has sulfur-related vulnerabilities, with about 460,000 tons produced via HPAL in Indonesia, accounting for 12% of global nickel supply, relying on sulfur imports from the Middle East.

Although buffers for nickel may be smaller than for copper, we see aluminum’s dislocation and disruption as the most significant current supply risk.

Gold has fallen about 6% since the start of the conflict, raising doubts about its safe-haven status. Reasons include the rebound of the dollar and market expectations of Fed rate cuts cooling (amid rising energy prices and inflation). However, most of last week’s sell-off was driven by broad risk-off contagion among investors.

During market stress, gold initially gets caught in a “sell everything” trade. We will explore this contagion risk in more detail below, along with historical performance of gold before and after such events, as tactical references during high volatility.

While gold may remain vulnerable to contagion in the short term, we believe that the longer energy disruptions last, the greater the impact on inflation and economic growth, and the more likely the macro environment for gold will turn sharply bullish—especially if the Fed shifts aggressively toward easing due to dual employment mandates.

2. Base Metals—Differentiated First-Round Impact Due to Long-Term Strait of Hormuz Closure Buffer Differences

Aluminum remains our top bullish base metal.

Qatalum, the first Gulf aluminum smelter to announce production cuts on March 3, has recently adjusted plans, stating it will maintain 60% capacity (about 650,000 tons/year) if sufficient natural gas supplies are available.

While this slightly reduces potential supply losses, the plant still cannot ship through the Strait of Hormuz and relies on imported alumina. Assuming full capacity with 20-30 days of alumina inventory, operating at 60% means inventories could last 30-50 days, but further production cuts will depend on alumina stock depletion in the coming weeks.

Overall, we believe this does not fundamentally change the fact that aluminum is approaching a supply-driven bull market if the Strait remains effectively closed. If shipping restrictions persist in the coming weeks, more production cuts are likely, causing market dislocation to evolve into a more severe and lasting supply shortage, with aluminum prices potentially soaring above $4,000/ton before demand-driven corrections.

Copper also faces supply chain issues, but buffers before disruption may be larger.

Despite declining risk appetite and a strengthening dollar, copper has shown resilience. One supporting factor could be sulfur supply chain disruptions—50% of shipped sulfur globally comes from the Middle East.

Sulfur and downstream sulfuric acid are critical for SX/EW copper production, which yields about 5 million tons annually, representing 18% of global refined copper. Chile mainly imports sulfur from Canada, the US, and Turkey, while last year, South Africa and Congo’s sulfur imports were almost entirely from the Middle East.

CRU data shows that nearly 3.6 million tons (60%) of Congo’s sulfuric acid demand last year was supplied by imported sulfur. Given that producing 1 ton of cathode copper requires about 1.93 tons of acid, this could impact about 1.8 million tons of Congo SX/EW copper, or roughly 7% of global refined copper supply.

However, buffers before disruption could be quite long. CRU estimates about 2-3 months of elemental sulfur inventories in the region, plus 1-3 months of transportation from the Middle East, totaling a 4-6 month buffer before significant downstream impact.

Additionally, adjusting ore processing sequences and leaching conditions can reduce net acid consumption, partially offsetting impacts on copper in the future. Therefore, a substantial supply disruption in Congo SX/EW copper would likely require a long-term Strait of Hormuz closure, which would also have severe macroeconomic and demand consequences.

In summary, for copper, this is more a matter of timing. Despite large potential supply risks, the relatively long sulfur supply chain buffers suggest that before supply shortages become critical, the first risk is a sharp price decline driven by macroeconomic reassessment.

Indonesian HPAL nickel production also faces risks.

Sulfur, once converted to sulfuric acid, is a key input for HPAL nickel production. Indonesia’s production risk is significant because: 1) about 80% of its sulfur demand depends on imports from the Middle East; 2) its supply chain buffer may be less than copper’s, with about 1 month of transportation time from the Middle East.

Last year, Indonesian HPAL producers supplied about 460,000 tons of nickel, or 12% of global supply. While costs are a factor—chemical inputs (including acid) account for nearly 60% of HPAL costs—these operations are generally low-cost (below $8,000/ton), so a complete disruption remains a key bullish supply risk.

In our view, during the initial phase of long-term Strait of Hormuz closure, nickel’s position is between aluminum (bullish) and copper (bearish). Major HPAL producers are reportedly halting long-term contracts, highlighting that sizable production is already under supply chain pressure.

However, a true supply shock would likely require months of closure, similar to copper, initially causing broad demand/ macro concerns and a general decline in nickel prices, followed by supply rebalancing.

3. Gold—Beware of sharp declines driven by risk-off before stronger catalysts emerge

Over the past two weeks, we’ve been asked repeatedly: why hasn’t gold performed like a safe haven (initial sharp pullback last week, pressure again this weekend)? How should we tactically respond?

As we noted in our initial reaction, the risk premium for gold during conflicts tends to be short-lived, exhibiting a “buy the rumor, sell the fact” pattern.

Additionally, the initial sharp rebound of the dollar and rising energy prices—raising inflation expectations and weakening Fed rate cut expectations—continue to exert downward pressure.

We believe another dynamic worth exploring is the contagion effect caused by rising equity volatility, which can trigger broad risk-off flows, leading to ETF outflows and sharp reversals in gold prices last week.

Figures 3-6 illustrate the cumulative changes in implied Fed funds rate (OIS), DXY dollar index, weekly changes in global gold ETF holdings, and VIX.

Gold is not immune to “sell everything” shocks

When VIX is high and rising, gold initially gets caught in a “sell everything” trade.

From a tactical perspective, the longer the Strait of Hormuz remains closed, disrupting energy flows and global supply chains, the higher the market volatility, and the more significant this contagion risk becomes for gold.

Generally, during market or equity stress periods, this “sell everything” dynamic in gold stems from investors seeking liquidity, raising margin calls, rebalancing portfolios, and managing VaR shocks, leading to broad risk-off behavior.

Data confirms this: analyzing weekly gold returns across different VIX ranges shows that when VIX >30 and rising, gold faces greater resistance during stock market contractions. In this zone, the proportion of positive weekly returns drops to only 45%, with average weekly returns turning negative—this is the only group showing such a pattern.

In silver, this safe-haven contagion effect is even more pronounced: in high and rising VIX environments, silver declines about 61% of the time, with an average weekly drop exceeding 2%. The dollar’s initial strength may also play a role, as in high and rising VIX conditions, the DXY tends to see asymmetric buying.

Figures 7-10 illustrate the weekly average and median returns of S&P 500, gold, silver, and DXY across VIX ranges.

Beyond the absolute VIX level, the trend matters too—gold in high but decreasing VIX environments can shift from the most bearish to the most bullish zones.

To analyze this timing more precisely, we examined 25 discrete cases since 2006 where VIX broke into high zones. In most cases (except during the 2008 financial crisis, 2011, and 2020 COVID-19), VIX quickly fell back below 30 within 10-15 trading days.

Tracking gold’s average price during these phases shows that in the first few days after VIX exceeds 30, gold faces intense selling pressure (average decline about 0.5%), but from day 3 onward, a rapid and sustained rebound begins, lasting over a week on average. During this rebound, gold typically recovers to pre-breakout levels by day 4 and gains over 2% from trough to peak around day 10.

Figures 11-13 depict the average performance of gold and silver during VIX breaches, and the proportion of days where prices are above or below pre-breakout levels.

Energy prices rising higher and lasting longer increases the likelihood of dovish Fed reactions.

Looking beyond short-term tactics, although rising oil prices and inflation expectations—along with easing rate expectations—may cause some near-term gold declines, we believe that in a scenario of prolonged Strait of Hormuz closure, gold will trend sharply higher.

Primarily, inflation—despite the commodity index tracking inflation more closely month-to-month—has historically been a stable hedge during rapid and sustained inflation periods. Given current oil risk-driven inflation dynamics, this framework remains valid.

Since 2000, the US CPI has experienced five episodes of relatively sustained and significant increases exceeding 2.5 percentage points. In four of these (excluding the recent surge post-COVID), gold posted double-digit gains. Especially in stagflation environments driven by oil shocks, gold remains a key hedge.

Figures 14-15 illustrate these periods and compare gold’s performance against the Bloomberg Commodity Index (BCOM), with the only exception being the post-COVID inflation spike.

Second, the Fed’s reaction function—before next week’s meeting, our economists believe moderate oil price increases (as currently seen) will keep the Fed on hold. However, if oil prices rise more significantly and persistently, the Fed may turn dovish. Higher and more persistent oil prices exert nonlinear downward pressure on growth, increasingly weighing on employment.

While this may also cause broader inflation to spike, the transmission to core inflation appears limited. If oil prices surge to $120/bbl or higher due to actual or expected supply reductions, our economists expect the Fed to lean toward easing again, as economic activity risks decline.

4. Conclusion

Although risk-off sentiment has somewhat impacted gold over the past two weeks, in the short term, gold may still be affected by broader risk-off events—especially if stock markets suddenly price in significant and persistent global economic downturns, triggering liquidity concerns.

Additionally, as interest rate markets continue to price out remaining Fed rate cuts, gold could face further near-term downward pressure. While caution is warranted regarding a potential further sharp decline, the longer the disruptions last, the greater the impact on inflation and economic growth, and we believe the macro backdrop for gold will quickly turn strongly bullish, especially if the Fed shifts rapidly toward easing, amplifying this trend.