5 - Putin in a shift
A resurgent Russia flexes its geopolitical muscle more than anyone could expect, oil shoots up to $150 a barrel
Consensus view: Markets are pricing in another year of range-bound oil prices as Russia shrugs off the latest US sanctions (i.e. target firms building Nord Stream 2, an undersea pipeline that will allow Russia to increase gas exports to Germany, which the US considers a “tool of coercion”). Even the assassination of General Qasem Soleimani in early-January – a seismic event in the Middle East – raised prices for Brent crude just about 5% (ca. $66 a barrel to ca. $70 a barrel).
What the consensus view is not pricing in: When it comes to oil prices, many focus on the Middle East. However, Russia may actually be the swing factor. In the last decade, Russia has unshackled itself from its post-Cold War funk and reasserted itself on the global stage in a major way: Ukraine’s annexation; critical backing for the Syrian and Iranian regimes which has tilted the balance of power in the Middle East; US general election interference in 2016; alleged assassination attempts of former spies, including in the UK; huge African investments, and thus influence. Much of this would have been unthinkable in 2010. At the start of 2020, a strategic attack on a missile bunker in the Baltics or similar is also unthinkable, but that is why it’s not priced in. The risk is also heightened as the US president will be under huge pressure in an election year to “rectify the sins” of Russian interference in 2016.
Potential market reaction:
Macro: Russia produced about 11.4 million barrels of oil per day in 2019, accounting for 11% of world output. Any actions that would result in an armed response by NATO against Russia would cause energy prices to skyrocket, with oil shooting up to $150. Instantly, headline inflation – long missing in most of the Western world – would shoot up, but it would be the unwelcome kind generated by a negative shock.
Asset allocation: Risk-off sentiment would cause equities to sell-off, but bonds will be crushed by the inflation factor. In this environment, gold prices would go through the roof, crossing perhaps the all-time highs (i.e. in real terms) achieved in 1979 when Russia invaded Afghanistan.
Our positioning: We have all been dulled by the constant cacophony of geopolitics. Indeed, there is much evidence that it tends to be a red herring in terms of risk allocations, and thus best ignored for asset allocation purposes. However, it certainly impacts certain markets, such as commodities, if they’re directly in the line of fire (pun intended). We have a large allocation to gold particularly to help insulate portfolios somewhat in the event such “black swan” events.