When it rains, it pours
This has been … an interesting month…
I am of course referring to the Russian invasion of Ukraine, but not only. We also saw the Canadian government freezing the bank accounts of its political opponents and anybody that “supports protesters”, whatever that means.
Meanwhile, Russia’s central bank foreign reserves have been seized, confirming that the only safe asset a country can own is gold in its own vault in its own territory. All the rest is just convenient fiction. I am sure the whole of Asia took notice, starting from China
We are also seeing this week all kinds of commodities, food, and energy blowing up in a way that gives some credential to all the hyperinflation worriers.
Fun…
Meanwhile, my whole family was dealing with a nasty outbreak of Covid, so I have mostly watched the last 3 weeks unfold from the sidelines, between fever and coughing and lack of energy, and handling a sick 3-year old.
Fun…
Wondering about invasion risk in Estonia while everybody’s sick was an experience I will remember for a lifetime.
But well at least my portfolio is doing great so there that. Cresud/CRESY is going up thanks to Argentinian food production, Transocean/RIG is finally getting the attention it deserves and Petrobras/PBR is doing fine with growing dividends. And hydropower Copel/ELP is steady as always. My gold miners MML and RRL are slow to react, but I can live with that.
What is going on
What needs to be understood is something I have been warning for years. The post-cold war era of the US-dominated order has ended. The rivalry between empires is back on the menu.
In parallel to western societies getting more and more fractured, this means that investors simply cannot just focus on cash flow, balance sheet, and growth rate. Many obsess over macro-like interest rates but miss the elephant in the room that is the rise of Eurasia as an independent and assertive political player.
If time allows, I might start a non-investing publication here covering this radical turn of events. Relevant macro analyses will increasingly be more about strategic deals between nations, the flow of energy and food and technology between great powers, and less about petty guesses about the Fed and the ECB.
In my CNOOC article, I had warned about the suddenly changed attitude of Russian officials in their diplomatic exchanges. This had forced me to sell my Gazprom shares close to the top, instead of just looking myopically at the future dividend yield. Investors will need to stay on top of such risks if they want to avoid disaster.
Nor is such risk limited to non-Western nations. When the White House can cancel the Keystone XL pipeline overnight over ideological reasons, or when the Canadian government suspends its political opponents’ bank accounts, or Australia banning all travel internally for 2 years, rule of law becomes a quickly fading concept in the world.
I truly deplore it, but not much I can do about it.
From an investment perspective, we need to integrate it.
Quick investing lessons
Commodity boom and consequences
First, disruption, shortage, and logistical nightmare are here to stay. With no one fully sure of where the shoe drop next, stockpiling and hoarding will become the norm. This is good for commodities producers IF THEY ARE UNHEDGED.
Producers that have locked in price before the price rise will be squeezed by higher production costs (salary inflation, oil price, shipping costs) and have a chance of getting a margin call on their hedge.
It seems to have happened this Monday on nickel. It might happen again. This is the kind of graph you only see when stuff in the financial system and supply chain is breaking.
If you do not believe the commodity will stay high, why buy a commodity producer in the first place? Buying a hedged commodity producer is a sure way to the problem if everything goes well. Bad idea.
You would believe the constant disaster with hedging from shale oil producers would have given a hint.
Apparently not.
Worry contagion
Secondly, investors’ worries will weigh on Chinese stocks. Even if China never invade Taiwan, the shock of the Ukraine invasion will linger for a while.
So even if I think Tencent, JD.com, and Alibaba are world-class businesses, I expect the blood bath there to keep going for at least a few months. Maybe not much more, as markets have a notoriously short memory.
For now, a flight to safety will dominate everyone’s mind. This should be great for the US and food secure and energy-rich countries in South America like Brazil and Argentina.
Right now, the plan for me is to keep cashing in on the commodity boom and dividends from companies like Petrobras. And then cash out maybe in the summer or end of 2022 to switch to whatever sector is the most damaged by the inflation shock. And probably a bit more gold.
Europe's economy is toast
No matter how we look at it, our prospects here in Europe are bleak.
The Euro will be under pressure of capital fleeing away.
Energy costs will devastate the industry, especially chemical and manufacturing.
And already borderline bankrupt countries like my natal France will spend a lot more on defense and subsidizing energy bills. Not like the 1-year long revolt of the yellow vest had not been triggered by fuel price increase… (and only stopped by brutal repression and Covid)
Except for companies positioned to benefit from the growing poverty here, like discounter Pepco I covered 2 months ago, avoid Europe.
Consequence on the rest of the world of depression-like conditions for 500 million people of the developed world is yet to be seen.
Gold for the long-term harbor
Something is going to break in the world monetary order. Many people have realized that for a while, but this is now accelerating. Sanctions until now reserved for poor and relatively powerless third-world countries like Venezuela and Iran are being applied to a nuclear power controlling roughly 1/5 of the world landmass and resources.
Whether you think it is good or bad is irrelevant from an investing perspective. It is the reality we deal with.
We cannot doubt that Asian countries are taking notice. China, but also Vietnam, Pakistan, Laos, the Philipines, all the countries that might be tempted to lean toward the Chinese side will now look to have safer currency reserves. Kept at home in a vault.
In the long run, this is bad for the dollar, even if a flight to safety, for now, hides it. But this is also bad for all currencies. Who wants to hold yuan if China can take it from you? Who wants to hold euros if “they” can size it without warning?
This decade, gold is going to be more in demand than miners can deliver. And that before retail investors start to move as well, with inflation now sure to stay in double digits for a while.
The risk of nationalization of miners is a real concern in that context, geographical diversification will be vital.
Maybe physical holding is the only way to go.
I am still unsure about that one.
The emerging Eurasian triangle
China, on a collision course with the US for a while now, will take notice. It is already getting threatened with its own sanctions for not supporting Russian sanctions.
More likely it will instead use the occasion to grab all the Russian resources it can. At 10-20% of their real value …
Not a smart move. Not from Putin, not from the US.
Now China will have de facto a captive vassal state with no alternative. It will provide an abundance amount of metal, energy, and food to the country that dominates the world manufacturing.
In addition, this supply will be through the land, and cannot be blockaded by aircraft carriers. No good for the US sea power.
Transfer of space know-how and military tech is also likely to happen.
Together with Iran, Russia and China will form a triangle able to dominate Eurasia and if needed, will be able to be completely autonomous from the rest of the world.
Hostility to and from the US will likely be the glue holding it together.
China provides the factory, IT, and critical mass of population and finance.
Russia provides the military tech, energy, metal, and foodstuff to ensure the safety of the bloc (bottom of Maslow pyramid).
Iran provides a young, growing, and cheap workforce to do the more menial work not anymore worth to do in soon-expensive China.
The “Stans” countries of Central Asia stuck between the 3 also provide other resources like uranium (Kazatomprom is roughly half of the world production) and oil&gas, as well as more cheap labor.
The key problem of such an autocratic autonomous bloc will be key techs like American chips patents and german industrial tools. With time, they are likely to develop their own passable substitute.
Deglobalization on steroids for the foreseeable future.
The next investing theme
Until 2020, the right theme was to position yourself in was tech.
In 2020, it was obviously pandemic winners, digitalization, and remote work (I missed that one entirely)
In 2021 energy was an obvious pick after negative oil prices the year before. Hard to be more at the bottom than negative prices.
In 2022 the dominant theme will be inflation, especially food inflation. See below the chart for wheat prices.
See the vertical point on the right?
Maybe in 2023, it will be Chinese tech or crashed down electric stocks and US tech, battered Eastern European stocks, who the hell knows…
The war-grain connection
Part of the 2022 food thematic is because Ukraine and Russia are such a massive part of the world's grain exports. Most of the Middle East imports 50-80% of its grain from these 2. Ukraine planting season will probably not happen, and Russia cannot export. Russia and Belarus are also the massive producers of fertilizers, of which exports have been banned before the Ukraine invasion.
Chips and oil shortages are going to be ignored if food is rare. This is just the most basic need above all.
A new Arab Spring is likely, so in addition to Europe, avoid the Middle East. A new refugee crisis with the massive flow of economic migrants will likely add to the millions of Ukrainians resettling westward.
The energy-fertilizer link
Part of the issue is that nitrogen fertilizers are made with natural gas. Most of Europe's production is already stopped since December. China, Russia, and Belarus have banned exporting. Ukraine is out as well.
With the planting seasons in WEEKS, the next harvest will be dreadful as fertilizer will be lacking when the plants need it.
This is not a speculative forecast, this is done. Decided. Over.
How to trade it? I am not sure
Cresud / CRESY was my way to hedge food risk, but I am uncomfortable making too large a bet on Argentina. It is still a country legendary for its boom and bust. So if I want to have exposure to farmlands, I cannot go with 30-40% of my portfolio on Cresud. And with Copel and Petrobras, I also have already too much Brazil exposure.
In another world, I would have aimed for Ukraine and Russia. Obviously not happening.
Europe fertilizer shortages put it out of question. And US and Australian firms seem already very pricy.
Maybe Japan? Indonesia?
Grass-fed beef? Is any are publicly traded?
If you know any large farming company, at a reasonable price and publicly traded, I beg you, tell me.
I’ll owe you one, literally.
And I will be able to share it with the other readers.
Meanwhile, I guess I will keep “hedging” food prices by buying fertilizers for my garden and gardening as a hobby…
Before thinking of making money, please all stay safe and take time for your family. That’s what matters in the end. If we all never forgot it, the world would be a better place.
Excellent excellent excellent! Highly recommend your easy to understand analysis
Excellent analysis as usual Jonathan!