More than two years ago, when Syria was off most analysts' radars, I wrote two Seeking Alpha articles (here and here) warning about potential trouble there. Back then I thought most investors were not concerned enough about the risk from Syria. Now I think they're too concerned. With a little background, I can explain why.
A Trip to Damascus
Years ago I traveled to Damascus. My first night there I was awakened by shouting under my balcony. It was some members of Rifaat Assad's private army, nicknamed the "pink panthers" because of their delightful pink and green camouflage uniforms. They were arguing with members of as-Saiqi (a Syrian-Palestinian army, who favored more conservative grey camouflage). Whether it was a fashion disagreement or something else, they were shooting Kalashnikovs at each other within minutes. Then a third army swept in, wearing plain-clothes. This group, who I'm guessing were Hafez Assad's Mukhabarat, managed to clear out the first two groups.
That, in a nutshell, is Syria. It is a country where one general may get turned away by a private at a checkpoint set up by another general. Where foreigners (like Russians, Palestinians, Lebanese, and Iranians) have their own armed forces. Where a dazzling panoply of religious and ethnic groups -- Sunnis, Alawis, Kurds, Circassians, Christians, Druze, to mention a few -- form an ever-shifting kaleidoscope of shifting alliances and enmities.
This is one reason President Obama will not take any action to remove, or completely disable, Assad. With all the semi-independent armies running loose in Syria, it will never be clear who actually used the chemical weapons and who they report to. Just as Hafez Assad's brother Rifaat was getting out of hand when I visited Damascus, there are now indications that Bashar Assad's brother Maher is doing the same.
Moreover, removing Assad would be even worse than removing Tito from Yugoslavia 50 years ago. He is the one element holding the dangerous mess together. His removal would unleash a whirlwind of competing groups (most of them inimical to us), all trying to get their hands on the Sarin gas. It's much better to deal with one rational thug who you know than a hundred crazy thugs who you don't know. Israeli officials have also noted this and the U.S. will not ignore the strategic concerns of its closest ally in the region.
A Slap on the Wrist
The most likely outcome of the most recent chemical weapons attack, will be a "slap on the wrist" by the U.S. and a few Nato allies. Most likely, they will try to cripple Syria's air-power. The Syrian air force is dominated by Assad's Alawi compatriots and can easily be targeted with minimal collateral damage (since the airfields are located outside of major population centers). "But won't that risk dangerous retaliation against Israel, or even the U.S.?" you ask. Actually no. As long as the attacks are not too extensive, there's a good chance the Syrian government will play them down or even deny they ever occurred. This has happened more than once before when Israel launched surgical strikes against Syria. The most recent strike, Operation Orchard, took out an alleged Syrian reactor in 2007. The Syrian government denied the attack ever took place, probably fearing that it would look weak or that it would be compelled to start a retaliatory spiral.
Muddle Through and Pressure Russia
The wisest, and most likely, course for the U.S. will be to limit its attack and use the threat of a wider attack or regime change to pressure Russia to get Syria's chemical weapons under control. There are indications that Russia has used its leverage with Syria before to isolate the chemical weapons in certain areas. I suspect it will do this again.
The Assad family has managed to stay in power for 40 years against steep odds. It belongs to a tiny religious minority, known as Alawi (or Nusayri), which most Sunni Muslims consider to be heretical. Alawis account for less than 15% of Syria's population. They have only succeeded by being both ruthless and pragmatic. The world recently saw the ruthless side. My guess is we're about to see the pragmatic side. An agreement to give up the chemical weapons to Russia in exchange for another lease on life is a distinct possibility at this point.
What Should Investors Do?
I think the hyperbolic claims about $150 oil because of the Syrian situation are greatly overblown. The reality is Syria is an insignificant producer of oil itself. Although Iran has ties with Syria, it desperately needs to prop up its economy to hold off its own discontents. The last thing it wants to do is curtail its oil exports. A real threat to the Kirkuk-Ceyhan pipeline is also unlikely. Turkey has the sixth largest standing army in the world and will fiercely defend its territory.
I see Turkish stocks as a tremendous bargain. The Turkey ETF (TUR) and Turkcell (TKC) have both been beaten down to the lowest level in over a year partly by overall Emerging Market weakness, but also by the Syrian situation. Yet, Turkey's GDP is expected to grow around 4% this year, faster than any other OECD country.
I am buying Puts on Oil futures. The implied volatility on November options is only around 26%, which seems cheap considering the potential fall in oil prices. Investors who don't have access to futures markets may consider Puts on the oil ETF (USO) or the leveraged oil ETF (UCO). I am not shorting anything outright. The risk of an enormous spike in oil prices before they drop is too high for that. As I have discussed elsewhere, leveraged ETFs have too much decay drag. So I am avoiding the Proshares ultrashort oil ETF (SCO).
Additional disclosure: I am also long on Oil Futures Puts.Please note I am not a registered investment adviser and do not provide investment advice. Please seek the advice of a professional adviser before investing.