The Impact of the “War Cycle” on Markets: High Tension Metals
The Cold War supposedly ended in 1989 but it would appear that somewhere or other there has been a major regional war going on since that time. Just when it appeared that Iraq and Afghanistan were behind us, along came Syria and rising tensions over the Crimea.
Of course any war is “good” for gold, both in demand and prices. The people in the war zone want the metal as a store of value if they need to flee while the broader global economy players tend to harbour gold because it’s hard to think of any war that does not produce inflation or money supply expansion of some sort for the armaments ramp-up is always an extra expense with the printing press being the easiest way to fund the war and keep a restless populace at bay.
On other commodities though, while the Iraqi war disrupted oil supplies, it did not appreciably effect metals. The Afghan economy has principally been known for supplying opiates, so metal markets were not drawn into the conflict. Likewise the Syrian conflict is only effecting oil supplies marginally as the country is such a bit-player in OPEC. However the latest escalation in tensions between Russia and the West is the first time in a very long age that a meaningful event might occur involving one of the world’s major diversified metals producers being taken out of the equation or at least isolated from the mainstream of metals trading. The last time we can think of was back in the old Cold War days when the West tried to isolate the Soviet Union over its invasion of Afghanistan in the early 1980s. That however was a dramatically different kettle of fish then because the supply of Russian metals was very marginal to the West and thus shutting it off had minimal effect.
In this piece we shall look at the metals most vulnerable to disruption from sabre-rattling in either direction. Then we shall also look at some long term consequences of the “New World Order”.
Throwing Stones in a Glasshouse
Some have accused the EU and US of soft-pedaling on the Crimea/Ukraine issue. Well might these economic powers think twice before stirring up too much of a ruckus. The EU is particularly vulnerable to Russia cutting off natural gas exports and the US has to play nice with Russia to keep getting cheap uranium supplies.
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Uranium: According to the US Energy Administration, in 2011 the United States mined 9% of the uranium consumed by its nuclear power plants. The remainder was imported, principally from Russia (50%), Canada, and Australia. As uranium bulls will ceaselessly inform you the supply situation is tight and if it wasn’t for those pesky Russians the price would be a lot higher. We usually do not make common cause with the tin-foil-hatted but would beg to agree with the uranium bulls. It is a truism that the unwinding of the Soviet stockpiles have beggared the global uranium mining industry and that the great day will be when an end to this attrition is seen. The current events might bring this around sooner rather than later. Just as the recent House of Cards series highlighted the somewhat mystical (and downright incorrect) applications of Samarium in nuclear energy, it is really with the far better known, and far less prosaic, uranium that the Russians have the US dancing on some rather short marionette strings. Basically if Russia decides to sit on its stockpiles, slow down supplies, cite inventory errors or whatever, then we would have a Cold War in a hot metal. Frankly, with Putin being a far better Machiavellian than any of his adversaries, it does not require us to tell him that this is the obvious play. The stockpile selling game was coming to a close anyway and it would be a good moment for him to bring it to a foreshortened end. There is no swing producer and there is no appreciable stockpile (beyond what the uranium ETF, Uranium Participation Corp has stashed away). The price could spike to over $120 per lb in the spot market easily if Russia let its intentions to place this card be known.
PGMs: The US, the EU and pretty much everybody else have only two main sources of PGMs, Russia and South Africa. The supplies from elsewhere scarcely matter. Russia has been the reliable supplier and South Africa the increasingly erratic one. This is not a metal sitting around in large stockpiles (the Soviet ones are now gone) and neither is there the scrap potential such as gold has if the price goes up. The average householder’s supply of PGMs is sitting in their garage or driveway and cannot be melted down like old earrings. If Russia instructs a shutdown of PGM exports, the price could double. This would be good for platinum juniors (of which there are scarcely any plays out there these days). It would be good for majors (mainly South African). It would be encouraging for major wannabes (like Polymet and Duluth) but doesn’t actually bring anything more than a price spike along the long haul to production for their mines, which only have PGMs as by-products anyway.
Nickel/Cobalt: Norilsk is an 800-lb gorilla in the nickel space with Vale as the challenger. Russia by no means dominates the nickel and cobalt space. However it is one of the biggest suppliers of cobalt to the West (we might remind that the US has foresworn the cobalt produced by Sherritt out of Moa Bay in Cuba). Any reduction in the Russian supply of these metals would lift prices, particularly as nickel is going through an interesting moment currently with the Indonesians also choking off as much as 25% of global supply. Russia pulling out would be more fuel for the fire under that base metal.
Others: The Russian economy is not the closed box that it once was in the days of the USSR’s invasion of Afghanistan or the Cuban missile crisis. A lot of gold that is being produced in Russia comes from companies that are wholly or in part foreign owned. EU or US sanctions on the Russian economy and its players may cramp their style as much as it hits the oligarchs and Putin inner circle.
Asian economies have been a ‘war-footing” in a sotto voce way for a number of years now. The Japanese, Koreans and Taiwanese have become increasingly concerned at the ability of the Chinese to potentially hold them hostage. It’s interesting then the country most likely to generate disruptions to global metals market is Russia at this time through its actions in the Ukrainian crisis. This does not make China any less of the threat in the longer term but it does focus the mind that problems can come out of left-field and that the West has left itself vulnerable to disruptions. At least actions taken by the Chinese have spurred these countries to source alternative supplies and they are engaged in a reconversion of their supply sources and rethinking the wisdom of planting industrial facilities on the Chinese mainland.
The US though is truly the frog in the boiling water. Despite the alarm bells going off on Rare Earths a good four years ago now, and then being followed by concerns across a swathe of other metals, the move by the US to return to strategic stockpiling has been de minimis and NO prioritization of ensuring supplies of the most vital metals exist in the Western hemisphere has taken place. A few visionaries in the legislature have pushed for the Rare Earth issue, but any mention of the swathe of other metals (two good examples of this being tin and antimony) of which the US has NO stockpile, or no Western Hemisphere supply source, causes Congressmen to glaze over. It was interesting recently to read that when the Second World War started the US had no tin production and the only deposits it had in Alaska were inadequate for its needs, so it was dependent on Bolivia. We might note that relations with Bolivia these days are not as rosy as they were in 1942 and that the South American nation is barely a shadow now of what it was in the tin production stakes back then. This is but a microcosm of the same problem repeated across the broad array of minerals. In the 1930s the US was largely autarkic in its base metal needs and supply (particularly if Canada was added into the equation). This situation continued right up until the 1960s. The same could not be said now.
The US is not only vulnerable to a hot war (submarines harassing ships, blockades or trade route disruptions) but is at risk from colder war scenarios, such as boycotts and trade restrictions that work both ways. The EU and Europe can bring in sanctions on Russia, but what if the Russians decided to keep their metals and minerals (and oil & gas) and restrict supply to the West for six months. The West exports almost no commodities to Russia so its hold over Russia is much less than the other way around. Russia need not even suffer by not selling oil to the West as it can filter that out the backdoor to China.
The West could get on a high horse and wield sanctions much more effectively if it wasn’t in such a vulnerable position, with either whole or significant dependency on products sourced out of Russia. I think we have shown here that are some products the US is particularly vulnerable to supply constriction. Beyond that the West is in danger of price spikes in some key products if the swing production the Russians provide is temporarily withdrawn (or blocked). The “just-in-time” strategies of Detroit’s auto-makers go out the window if they cannot get platinum for their auto catalysts. A dramatic run-up in prices would be the only way to achieve market balance, with a pleasing outcome for those non-Russian suppliers of metals seeing temporary (we hope) disruptions.
Christopher Ecclestone is a Principal and mining strategist at Hallgarten & Company in London. Prior to founding Hallgarten & Company in New York in 2003 ... <Read more about Christopher Ecclestone>