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Will a New War in Iraq Cause Oil Prices to Soar?

The situation in Iraq is deteriorating rapidly, bringing with it the possibility that the Middle Eastern country could soon splinter into three separately governed territories.

Will violence cause oil prices to spike?
According to media reports, an extremist group with ties to Al-Qaeda has taken the strategically significant cities of Mosul and Tikrit, the latter just 87 miles North of Baghdad.

Meanwhile, Kurdish forces have advanced south and seized the oil-rich city of Kirkuk.

While the Middle East is no stranger to internal conflict -- and particularly since the so-called Arab Spring began ousting rulers at the end of 2010 -- Iraq's massive oil reserves globalize the stakes of the current violence.

According to estimates, Iraq has the fifth largest proven oil reserves in the world, after only Venezuela, Saudi Arabia, Canada, and Iran.

Given this, investors and energy experts have begun speculating about the potential impact an all-out civil war might have on markets in general and global oil prices in particular.

"Oil futures posted their largest weekly gain since December as a Sunni insurgency in Iraq jolted the market, fueling fears of reduced oil output from one of the world's largest crude producers," reads a recent article in The Wall Street Journal.

What past conflicts suggest ...
If history is any guide, there's legitimate reason for concern.

As the following chart shows, oil prices spiked, albeit temporarily, both times military conflict enveloped Iraq -- that is, during the first and second Gulf Wars.

For enterprising investors, do specific companies or industries stand to profit from the developing series of unfortunate events?

"As investors try to determine what stocks and which sectors would benefit if we continue to see troubles in Iraq, it's logical that more defensive sectors would benefit, and especially the defense stocks themselves," an investment strategist told Yahoo!'s Chuck Mikolajczak.

The companies that come immediately to mind are Lockheed Martin, Boeing, Raytheon, and United Technologies.

Another option is to consider a defense sector exchange-traded fund like the iShares U.S. Aerospace & Defense (NYSEMKT: ITA  ) , which "seeks to track the investment results of an index composed of U.S. equities in the aerospace and defense sector."

A more cautious approach
While strategies like this seem to make sense, I would nevertheless urge investors to respond cautiously to news like this.

I say this for two reasons. First, it's well known that trading in and out of stocks based on geopolitical events is an almost certain loser. Even if you guess right, your gains will nevertheless be eroded thanks to trading fees and treatment as ordinary income.

And second, you can rest assured that you're already late to this game, as hedge funds and other sophisticated traders will have long ago made their move and extracted much of the profit from a short-term strategy of geopolitical arbitrage.

The smart thing to do, in other words, is absolutely nothing. As my colleague Morgan Housel recently wrote: "I've learned that 'do nothing' is the best advice for almost everyone almost all the time."

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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