Quarterly Investment Review – Q1 2022
“We need to increase oil and gas output immediately.”
Elon Musk, 5 March 2022
Just as the world economy was emerging from the Covid crisis it was overtaken by another crisis when Russia invaded Ukraine. Apart from the human trauma there are multiple economic impacts from this act. The main one is that it has made an energy crisis even more acute, but a string of other commodities’ supply have been affected. Russia is a commodity superpower producing 11% of the world’s oil, 17% of its natural gas, 40% of palladium, 15% of platinum and rhodium, 15% of aluminium, significant volumes of battery grade nickel, and 65% of neon (a rare gas used for semiconductor production). Russia and Ukraine account for 28% of global wheat trade. Belarus has 40% of the world’s potash, and Russia supplies 66% of ammonium nitrate (used for fertilizer). Many of these markets were already tight, and the loss of such a large provider will create huge upheaval as the world tries to reorganise its supplies. The inflationary pressures are clear, and they add to a situation which was already experiencing the highest inflation for forty years. On top of these pressures will be increased defence spending, which will further constrain government budgets and add to inflation. Wars are always inflationary. Before the invasion several areas of financial markets were struggling as Central Banks indicated that interest rates would rise through the rest of the year. Bonds had fallen as inflation rose, and profitless technology companies in the US fell precipitously. Most dramatic was the profit warning on 3rd February by Meta (formerly Facebook) which resulted in it losing $250bn of value that day. It is a measure of how concentrated the market is that its loss represented the combined total value of all but the top twenty companies in the S&P500. Yet this feature of the market also offers opportunity. The obsession with technology in the last decade means that large swathes of the market have been ignored, leaving plenty of decent companies on sensible valuations. Nonetheless the strong inflationary environment, with a super imposed geopolitical and commodity shock, has left all markets in an uncertain state. Longer term the most damaging consequence may be to the US dollar’s reserve currency status. The unilateral freezing of Russian reserves will make countries with large surpluses think twice about parking their reserves in the US bond market. The US has benefited from trillions of deposits from countries such as China, India, Saudi Arabia, UAE, and Kuwait. These reserves have allowed the US to run huge deficits at low cost, but if the inviolability of these reserves is questioned they may leave. That will put upward pressure on US interest rates, and downward pressure on the dollar.
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