Market volatility continues … why Russia isn’t likely to stop its aggression anytime soon … examining the broader global implications

 

As I write Tuesday early afternoon, gold has jumped to $2,036, after nearly toppling its all-time high of $2,067 earlier this morning.

Meanwhile, crude prices are at $123 a barrel after having pushed to nearly $130 this morning.

Behind these price jumps is news that the U.S. will be banning Russian oil and natural gas exports.

From AP News:

The U.S. will be acting alone, but in close consultation with European allies, who are more dependent on Russian energy supplies.

European nations have said they plan to reduce their reliance on Russia for their energy needs, but filling the void without crippling their economies will likely take some time.

One edit to the AP News story. The latest update as I write is that the U.K. is also banning all Russian oil imports. So, it’s not solely the United States taking this step.

Last week in the Digest, we noted that the West’s sanctions were not targeting Russian energy exports. That’s because doing so would be like pouring gasoline on the inflation fire that’s already burning through the U.S. and, to a lesser degree, Europe.

However, such sanctions are the best way to hit Russian President Vladimir Putin and his war efforts (independent of physical aggression). That’s because Russian energy exports account for 60% of the nation’s total exports.

Though President Biden has held off on this option, Putin has shown no sign of de-escalation. So, this last-choice strategy of oil sanctions will now become reality.

This is pushing oil prices higher, as traders wrestle with what will be an immense shock to the global supply/demand balance. The news is also sending gold higher based on general, global chaos.

Let’s zero in on this chaos in more detail.

There are tentacles of the Russian invasion into Ukraine that extend far deeper than many investors are considering. We should look at this and consider what it means for the global economy, all the way down to your specific portfolio.

***The ripple effects of Putin’s war

So, what do we know?

Well, at present, the West’s economic sanctions aren’t doing anything to stop Putin’s aggression. The hope is they will in time, especially now that oil is in the crosshairs, but we’re not seeing signs of that yet.

Plus, now that sanctions are being placed on Russian oil, it greatly increases the odds of a global recession.

The reality is that the world cannot suddenly replace Russian oil. That’s why Europe (excluding Great Britain) is not even trying at the moment. Russia supplies nearly 40% of Europe’s energy consumption, so Europe can’t suddenly turn off the spigot.

From Sky News:

…the EU has not yet been able to come up with a unified line on a possible ban on Russian oil and gas.

As Germany’s foreign minister, Annalena Baerbock, told the broadcaster ARD: “We must be able to hold [the sanctions] over time. It is useless if in three weeks we discover that we only have a few days of electricity left in Germany and that we must therefore reverse these sanctions.”

So, elevated oil prices will be a reality for the foreseeable future. And that has a very real impact on global consumers and corporate bottom lines.

But won’t oil sanctions also cripple Russia and end the conflict?

Well, yes and no.

***Russia’s ability to ride out sanctions

First, as we just saw, Europe has not yet signed on with Russian oil sanctions. They’re simply too dependent. So, Russia still has massive dollars flowing its way to help finance its aggression.

Meanwhile, though Russia will feel some pain, it has a backstop…

China.

The two countries have been growing closer in recent years, both politically and economically. Total trade between Russia and China jumped nearly 36% last year to a record $146.9 billion. China is now Russia’s biggest export destination.

Russia accounts for 15.5% of all of China’s oil imports. It’s also Beijing’s third-largest gas supplier, and its second largest coal supplier.

Bottom line, there’s a lot of economic lifeblood flowing back-and-forth between these countries that’s supporting Putin’s war efforts, in spite of Western sanctions.

Plus, as Western leaders have been quick to condemn Putin and apply sanctions, we’re seeing nothing of the sort from China.

Not only is China not condemning Russia, it’s publicly affirming the connection.

From DW.com yesterday:

China’s Foreign Minister Wang Yi emphasized China’s “rock-solid” friendship with Russia and said the prospects for cooperation between the two countries are very broad…

Wang said Russia was Beijing’s “most important strategic partner” and their bilateral relations were “conducive to world peace, stability, and development.”

“No matter how sinister the international situation is, both China and Russia will maintain their strategic determination and continuously push forward the comprehensive strategic partnership of coordination in the new era,” he said.

***And let’s throw in another wrinkle

Last week in the Digest, we suggested that if Putin felt cornered, he might decide to weaponize his oil exports. Yes, it seems counterintuitive as this would destroy parts of the Russian economy, but it would also be a point of massive leverage over the West.

Well, Putin is now making this overt threat in response to oil sanctions.

From Bloomberg:

Russia threatened to cut natural gas supplies to Europe via the Nord Stream 1 pipeline as part of its response to sanctions imposed over the invasion of Ukraine, a move that could heighten the turmoil in energy markets and drive consumer prices even higher.

Russia has the right to take actions that “mirror” the penalties imposed on the Russian economy, Deputy Prime Minister Alexander Novak — who’s also in charge of energy affairs — said in a televised speech late Monday.

He said no decision to shut off Nord Stream 1 has yet been taken, and the pipeline is currently operating “at its full capacity.”

The quick takeaway from all this is that Russia is likely determined to continue its aggression for far longer than many people realize. And given its relationship with China, as well as its inherent leverage with its oil, it has the ability to do so while inflicting massive economic damage on the world.

***The potential for a global recession and social instability

Now, let’s forget oil and gold for a moment. This conflict has the potential to be far bigger in scope.

Take food.

Ukraine alone accounts for more than 10% of the global wheat market. Throw in Russia, and that share jumps to more than 30%.

It’s not just wheat. There’s also corn and barley, which are important in feeding livestock. Together, Ukraine and Russia make up just under 30% of the world’s barley supply.

Then there’s sunflower oil, which is one of the world’s main vegetable oils used for cooking. Ukraine and Russia make up 80% of the global supply.

And don’t forget fertilizer. Russia and Belarus make up 15% of global fertilizer needs.

Big picture, it’s estimated that Ukraine and Russia alone account for 12% of the “calories” that the world trades.

This is all being jeopardized.

So, what’s the implication?

Well, the best way to destabilize global populations is through food shortages. Soaring food costs were a leading factor in the Arab Spring uprising in Tunisia and Egypt back in 2010.

There’s a growing risk this will happen again.

From France 24:

Russia’s invasion of Ukraine could mean less bread on the table in Egypt, Lebanon, Yemen and elsewhere in the Arab world where millions already struggle to survive.

The region is heavily dependent on wheat supplies from the two countries which are now at war, and any shortages of the staple food have potential to bring unrest.

If those supplies are disrupted, “the Ukraine crisis could trigger renewed protests and instability” in several Middle East and North Africa countries, the Washington-based Middle East Institute said.

Though we might avoid similar food instability here in the U.S., we could certainly see far higher prices.

***It’s not just food that stands to be disrupted

An increasing number of Western businesses are joining the global effort to isolate Russia economically.

Companies that have stopped doing with business in Russia altogether or curtailed their economic exposure include Visa, Mastercard, Netflix, Samsung, BP, Shell, General Motors, Ford, Toyota, Volvo, Daimler, Levi Strauss, Microsoft, Apple, and Nike.

Earlier today, we learned McDonald’s will close 850 restaurants in Russia.

Now, are such missed revenues going to send McDonald’s or any of these companies into a tailspin? No. But they could impact a quarterly bottom line. Perhaps more than a quarter if the aggression continues.

And what about our beleaguered airlines, trying to claw back from the pandemic? How is their profitability going to be able to handle skyrocketing oil prices?

$200 oil is suddenly on the table. Think of how these fuel costs could eat into bottom lines when airline fuel hedges expire.

Now, what about the logistics of shipping goods all around the world?

Two of the biggest global shipping groups, Maersk and Mediterranean Shipping, have already suspended cargo booking to-and-from Russia given sanctions. The supply chain consultancy FourKites suggests ocean rates could double or triple.

So, what about air cargo? Can that make up the difference?

Well, countries around the world are closing airspace to Russian aircraft. This has prompted Russia to close its own airspace to Western cargo planes in retaliation. The problem is that Russia is a critical corridor from East to West. How will this impact already-thin supply chains?

Now, what about that new electric vehicle you wanted? Or that new solar paneling? Both of those technologies require huge amounts of copper, something we’ve covered in detail here in the Digest.

Yep, you guessed it – Russia has the world’s third-largest copper reserves, only behind Chile and Peru.

And don’t forget the potential impact on semiconductors that we touched on last week – Russia and Ukraine produce 40% to 50% of semiconductor-grade neon. Up to 75% of the world’s supply of neon is likely used to make semiconductors.

By the way, we haven’t even touched on the humanitarian issues here. Two million Ukrainian refugees have already fled Ukraine into Europe. How is this massive dislocation going to impact Europe – both economically and socially?

This is way bigger than an oil or gold trade. Russia has suddenly sent the global economy careening toward a recession.

***The world is facing a period of greater instability than any other time in decades

Barring an unexpected solution/ceasefire, we’re on a dangerous path.

Prices will be going up: gas, food, consumer goods; you name it. Meanwhile, the conditions that breed social instability will climb too.

Yes, own gold. Yes, own commodities and real estate. Yes, own high-quality stocks that can raise their prices to match inflation.

In the meantime, let’s hope that Western leaders offer Putin an off-ramp that enables him to deescalate while claiming some sort of victory, therein saving face. If not, this situation has the potential to be far bigger, and far more dangerous, than people realize.

Have a good evening,

Jeff Remsburg