By Marc Jones and Sinead Cruise
LONDON (Reuters) - Some investors trying to protect themselves from any market gyrations provoked by a deepening Syrian crisis are looking to oil as an alternative to top-rated government bonds, a traditional but currently unappealing haven in uncertain times.
With U.S. Treasuries and German bunds on course for their biggest annual losses since the mid-1990s, oil is being touted as a better bet - although many investors remain ready to endure some short-term pain in return for the liquidity that the huge government bond markets offer.
Some analysts believe crude oil prices could jump more than 20 percent if a U.S. military strike on Damascus drags other countries into the Syrian conflict. "Our oil team think oil could go as far as $150 if we get the all-out scenario," said UBS global macro strategist Ramin Nakisa. "We have gone overweight energy, that is the obvious way to play it."
In past periods of geopolitical uncertainty, highly liquid U.S. or German sovereign bonds were the perfect investment bunker during crises from Kosovo to Iraq to Libya. Investors parked funds in Treasures and bunds to wait until the outcome became clearer, and markets rallied relatively quickly anyway.
This time the option of sitting it out is less attractive. The U.S. Federal Reserve is planning at some stage to start winding down the huge purchases of bonds it has been making to stimulate the American economy, and growth also appears to be picking up at last in other major Western countries.
This has helped to bring a virtually unbroken 20-year bull market in government bonds to an end, although the credit quality of core government bonds and the way they can be traded like cash remain critical attributes of "safety" plays.
Other familiar safety plays such as Swiss franc cash or gold present similar problems: both became overpriced due to fears about the state of the financial system that have since ebbed.
Short term demand is growing for oil as well as energy-linked stocks and currencies that tend to rise during Middle East conflicts. Apart from that, constructing trades on the options markets aimed at benefiting from a rise in volatility from current low levels seems one of the few alternatives.
"Volatility is another way to think about it," said Nakisa. "Volatility always spikes when you have geopolitical events and obviously volatility is very limited at the moment."
Over the last 10 days the STOXX oil and gas share index <.SXEP> has outperformed the general STOXX 600 <.STOXX> by roughly 5 percent and a number of institutions have issued buy recommendations on the sector.
However, so far the gains have been modest. "While it's a horrifying humanitarian tragedy, the market has not taken this episode too seriously yet," said Derek Mitchell, senior UK equities fund manager at Royal London Asset Management. "We have not seen many new positions with regards to oil firms. Most people are still very underweight, if they are in it at all."
In the currency market, the Canadian dollar and Norwegian Krone have risen against the yen. Canada and Norway are oil producers which would benefit from any major price rises, while Japan would suffer as one of the biggest crude importers.
World stocks <.MIWD00000PUS> slid in the run up to both U.S.-led wars with Iraq in 1991 and 2003, but rallied once the extent of the conflicts became clear.
The main worry now is that Iran, an ally of Damascus, could get involved if the United States goes ahead with attacking Syria. The entire region could become inflamed yet further, causing major oil supply problems. There are also concerns about how the crisis could affect relations between Washington and Russia and China, which oppose U.S. action.
In smaller previous conflicts, such as in Libya in 2011 and Kosovo in 1999, market volatility rose as tensions escalated but the effect on stocks and other financial markets was limited.
Didier Duret, chief investment officer at ABN Amro, said his base scenario is that Syria will also be a "short-term disturbance" for markets that won't derail the global economic recovery.
Historical data supports that view. Global purchasing managers' indexes, which track the manufacturing and services economies, did not react when Western government bombed Libya during its civil war. While the PMIs, which are seen as a good gauge of general economic confidence, plunged before the Iraq conflicts, they swiftly picked up once the wars were underway.
FAVOURING LIQUID ASSETS
During the financial crisis of 2008 many investors got stuck with assets they could not get rid of easily as their value fell. This time they are likely to favor liquid assets, even if holding bonds incurs short-term losses.
"We are concerned about Syria, but in all honesty, there's not much that you can do in preparation for something like this," said Matt Eagan, a Boston-based co-manager of the $22 billion Loomis Sayles Bond Fund. "We don't like U.S. Treasuries in the main but ... we know that they are one of the most liquid instruments in the bond world."
"2008 definitely gave you a different idea on what was genuinely liquid and what wasn't," he said.
Other countries with top credit ratings offer alternatives. "We also have some Canadian dollar positions, Canadian government bonds," said Eagan. "We have Norwegian bonds that are AAA, and when you add all these up we have around a fifth of the portfolio in high liquid instruments."
(additional reporting by Chris Vellacott, editing by David Stamp)