(Bloomberg) - Gulf dollar bonds went into the weekend as investor darlings and came out as risky assets.
Money managers poured into the Gulf region in the weeks running up to Saturday’s unprecedented attack on Saudi Arabia’s key oil facilities. That drove record gains for bonds in August as they sought refuge in securities boasting an average credit score of A+ amid global trade tensions.
When markets reopened on Monday, debt from all six of the Gulf Cooperation Council nations fell as the prospect of a conflict in the Middle East loomed. Saudi Arabian bonds handed investors the biggest loss, according to a Bloomberg Barclays index.
“The region always trades with a political risk premium and unfortunately these sorts of events reinforce the perception that the premium is warranted,” said Abdul Kadir Hussain, the head of fixed-income asset management at Dubai-based Arqaam Capital. “I would expect some selling in the short term.”
The strikes in Saudi Arabia could escalate into a showdown, with the kingdom and U.S. on one side, and Iran, which backs proxy groups from Yemen to Lebanon, on the other. Iranian-backed Houthi rebels in Yemen claimed responsibility for the assault and warned that oil installations in the Arab nation remain a target.
Saudi Arabia is responsible for almost a 10th of global crude output.
Too Close to Ignore
Until now, Gulf states have benefitted from higher oil revenue at moments of geopolitical tension, a phenomenon that offset the risks and conferred a haven status of sorts, according to Patrick Wacker, a fund manager for emerging-market fixed income at UOB Asset Management Ltd. in Singapore.
“However, that was so because the conflicts were at the periphery, such as Lebanon and Syria,” Wacker said. If there are more attacks on Saudi infrastructure, “this would be uncharted territory and require a meaningful risk premium - a risk premium not currently priced in by markets,” he added.
Depending how events unfold, Saturday’s attack could force investors to nuance their choices in the Gulf as issuers are no longer lumped together as a safety bet, according to Sara Grut, an analyst at Goldman Sachs Group Inc. in London.
Abu Dhabi and Oman may benefit if they step in with higher production when oil prices are elevated, Arqaam’s Hussain said. And while Qatari and Saudi debt normally outperforms during an uptick in prices, they suffer when the source of the spike is higher geopolitical risk in their region, according to Grut.
Oil posted its biggest-ever intraday jump on Monday, briefly surging above $71 a barrel. Saudi Aramco faces weeks or months before the majority of output is restored at the giant Abqaiq processing plant.
UOB’s Wacker said he pared some of his investments in Gulf bonds a few weeks before the attack, shifting into Russian, Hungarian and Uzbek securities as the advance in GCC debt since late last year made the bonds more expensive.
“This incident highlights the need for increased differentiation.”