It didn't happen at the UN, but soon, if not quite immediately, the Presidents of the United States and Iran are going to shake hands and then sit down together and make a deal. Iran will agree to a verifiable renunciation of nuclear weapons. The United States will agree to take the lead in removing economic sanctions. This will happen for a simple reason: it is greatly in the interest of all parties. Iran's economy will emerge from disastrous recession and runaway inflation, and President Rouhani will get the credit for it. The United States will avoid yet another military action in the Middle East - a particularly nasty and risky one. President Obama will achieve an unambiguous and redemptive success. Like Nixon in China and Carter brokering an Israeli-Egyptian peace, he will assure himself a modest place in history. The potential for slip-ups is considerable on both sides, but the election of Rouhani with backing from Supreme Leader Khamenei made a rapprochement between the U.S. and Iran the most probable outcome.
Iran Is Not the Country You Think It Is
Many Americans think of Iran as a country led by boorish figures like Ahmadinejad and full of angry mobs shouting "Death to America." This was never a true and complete image. Iran has had a mixed history with the U.S, but America remains the country of aspiration for middle class Iranians. The overall Iranian economy is heavily dependent upon oil exports, but it does not resemble other resource-exporting countries. Iran has a broadly based modern economy with its own domestic production of automobiles and military hardware. It also has wonderful green technologies for air conditioning and clever ways of moving water from the mountains to the population of Tehran and environs (scarcity of water being the country's great problem). Nevertheless there are areas of technology in which Iran has relied heavily on the outside world, large infrastructure projects among them.
Meanwhile sanctions have brought the Iranian economy to its knees. I was not initially a believer in sanctions, but reports from my wife's Iranian relatives as well as our own visits confirm a profound effect at all levels of society. Iran is experiencing the classic elements of stagflation - recession, steeply rising prices, and a steeply falling currency. Foreign goods are expensive if not absolutely unavailable. We are often asked to bring Western pharmaceuticals which are simply unavailable. Their major exports - oil and agricultural and food products - have limited access to world markets. They have no access to global banking, and their overseas accounts are frozen. It should come as no surprise then that the senior mullahs seem ready to negotiate. It's a matter of survival. When the deal is made and sanctions are lifted, the Iranian economy will simply explode. So how should you play it?
Germany as an Iran Play
There are several reasons to look to Germany as the prime economic beneficiary of a deal with Iran. Germany is of course a manufacturing powerhouse, but it is dependent upon imported energy, much of it from Russia with strings attached. Iranian oil has traditionally gone in large part to Europe. Bringing Iran's oil exports back to capacity is estimated to produce roughly a ten percent drop in global oil prices. Germany, with its high concentration of chemical (lower cost of feedstock) and other oil-intensive industries, will get the biggest pop.
Germany has a "special relationship" with Iran that other European nations do not share. The relationship goes back to Reza Shah, who was deposed by the advancing Allies in 1941 because of his pro-German views and replaced by his son (the Shah ousted by Mossadegh and reinstalled by the CIA in 1953, then ousted again by Khomeini and the 1979 Revolution). Iran has always distrusted its near neighbor Russia and made common cause with a distant Germany. In recent decades Iran and Germany have had a close business and trade relationship grounded in the fact that each exports what the other needs. Many German companies dragged their feet and complied with sanctions only under U.S. pressure. As an aside, Germany is roughly tied with Canada as the Western nation with the second largest number of overseas Iranians, about 120,000, behind only the United States. This "Iranian Diaspora," though largely driven into exile by the religious regime, maintains close ties with family and former associates in the old country and will facilitate renewed business ties.
When considering companies likely to benefit from business with Iran a short list of Last-Out-First-In candidates is a good place to start. Many of these companies provided expertise for large infrastructure projects such as refineries and petrochemical plants. Siemens (SI) and Linde (FWB: LIN) were among the last to withdraw, leaving established business relationships which should help them become the first to return. BASF (OTCQX:BASFY) was also active in Iran. The iShares MSCI Germany Index Fund (EWG) is heavily-weighted toward these and similar multinationals and is thus a good diversified alternative. Among non-German companies, both Royal Dutch Shell (RDS.A), (RDS.B) and Total (TOT) came under criticism for dragging their feet on sanctions and should be welcomed back quickly. It is important, however, to remember that the companies previously involved in Iran are quite large, and the incremental revenues from business in Iran will affect them only at the margin. You should have a generally positive view of the company or the ETF anyway and think of Iranian business and cheaper oil as a kicker.
Iran Itself as a (Re)Emerging Market
Even when sanctions are lifted and the Iranian markets are opened to Westerners it will take time for the dust to settle. Iran itself, however, is where the truly explosive growth will be. The Tehran Stock Exchange has existed since 1966. There are more than 300 listed companies, with 37 different industries and valuation in excess of 100 billion dollars. Iran is in the process of privatizing government corporations, a generally good thing, but many of these companies were controlled by more conservative elements. There will be an initial question of transparency. Many shares passed into the hands of novice investors of modest means, in part because of the manner of privatization and in part because of a paucity of other savings vehicles. Prices may be artificially inflated and should be analyzed closely.
It may be impossible to invest in Iran now, but once it becomes possible the returns should be explosive. Iran is a country of considerable scientific and technological sophistication, currently starved for capital. Half of the Iranian population is under the age of 25. The last time American demographics looked anything like this was 1968, when boomers started coming of age and Everybody Under 25 was the TIME Magazine Person of the Year. Such a large body of young people has infused Iranian culture with the values of the young - freedom, technology, fun, and the consumption of material goods. If you are an 85-year-old mullah, this is your worst nightmare. If you are a seller of consumer products it is your dream scenario. Stay tuned for specific investment ideas as this scenario unfolds.