Whether you call it a special military operation, a preemptive strike, an armed incursion or an outright war, the impact of Putin’s actions in Ukraine are likely to have long-term, far reaching impacts on economies around the world, but none more so than that of Ukraine and Russia. I personally believe that Mr. Putin may have underestimated the fierce determination of the Ukrainian people and their military, as well as, the resolve of the majority of the Western world to send a message that what he has done is unacceptable. Looking beyond the short term ramifications of various sanctions and export bans (which we’ll briefly discuss later), the long term impact of his actions could result in a sizeable hole that could take years, if the country can ever dig itself out of.

The primary focus for my thesis today is the importance, if not complete reliance of the Russian economy on fossil fuels. According to this BBC article, oil and gas provided 39% of the Russian federal budget revenue and made up 60% of Russian exports in 2019. This Reuters article suggests that by 2020 oil & gas accounted for over 23% of Russian GDP. It also states that overseas trade made up 46% of Russia’s GDP according to the World Bank. Oil and gas provided more than half its exports, with metals accounting for 11%, chemicals about 8% and food products 7%. Despite Russia being one of the largest global suppliers of wheat, fertilizer and a few other commodities, it’s oil and gas that grease the economic wheels and ultimately finance Mr. Putin’s war machine. Yet it seems Mr. Putin is willing to sacrifice his golden goose in pursuit of something that I’m not sure anyone in the world fully understands.

What do I mean by this? The theory is twofold. For starters, between Western sanctions being imposed on Russian energy and the denied but obvious “weaponization” of natural gas, Europe is rapidly advancing its move to alternative energy sources and ultimately renewable energy. Thus if/when this all settles down and things head back to pre-war type of activity, Russia’s fossil fuels could be worth a lot less due to a combination of demand destruction and more reliable suppliers. In particular, only 13% of the world’s natural gas is moved by tankers and the rest by pipelines. Russia has spent a lot of time and money developing the infrastructure to deliver gas to Europe that can’t readily be replaced to deliver comparable volumes to China, India or whoever is willing to do business with them. And without a lot of foreign investment and LNG expertise, it could be difficult for Russia to access global natural gas markets anywhere.

Following on from the European move away from fossil fuels to renewable energy (of note, I’m talking years not months). As global demand for fossil fuels begins to roll over, I’m pretty sure Middle East oil producers will be the last ones standing and Russia will still “lose” both market share and netback pricing. If Russia is relying on China to buy all their commodities they are likely in for a rude awakening because China tends to look out for #1 and is more than happy to put the screws to anyone who is in a weak bargaining position. My understanding is that today both China and India are already paying significant discounts to WTI or Brent prices for Russian crude, a lot more than the typical quality discount (similar to the heavy oil differential we see for a lot of Canadian crude). That will likely only get more punitive if the world moves to an oil supply surplus and customers have more choice over what regime they are willing to support.

As for what’s going on today, we see things like export bans impacting car and airplane parts. Russian car production, which accounts for over 600,000 Russian workers, is down over 90% in the last 6 months. It has led to Russia easing safety measures to allow cars be built and sold without airbags and anti-lock brakes amongst other measures. Russia’s commercial aircraft fleet is comprised of around 55%-60% of foreign built aircraft (primarily Boeing and Airbus) which are no longer providing parts or maintenance services meaning at some point there will probably be a dramatic drop in air travel capacity. This could have a significant impact on the economy given that over 50% of Russian GDP comes from the service industry which includes hotel and catering services, as well as culture and entertainment. Tough to see the service sector picking up the slack if people find it harder and harder to get from point A to point B.

Looking even further ahead into the future, sanctions and a lack of foreign investment today are likely to make things a lot harder for Russia to be able to develop its own renewable energy industry, albeit they do have most of the raw materials. This puts the country and the economy further in the hole as it relies on the rest of the world for technologies and investment to “catch up”, assuming renewable technologies achieve their goal of not just being better for the environment, but a far more economic source of energy.

I don’t have a crystal ball and I have no idea how this whole situation plays out. However, I find it hard to imagine a scenario where in 5 years from now Russia’s economy is in better shape than it was prior to February 24. And the Russian people have one person to “thank” for that.

Today we’re going to try something a little different. If successful it could become a recurring feature here at InvestorIntel, and if it falls flat on its face then it will never be heard from again. We’re calling it “Under the Hood” and the intention is to dig a little deeper into a Company, or perhaps a trading theme, or a trend that either doesn’t make a lot of sense to me (as is the case today) or perhaps has a lot of room to run from where it is currently trading. It’s simply my observations on a topic that is derived from spending far too much time watching the business news channels every day. Keep in mind, I am not a licensed investment advisor and may not extend buy or sell recommendations. Correspondingly, this should not be construed as investment advice, simple the ramblings of a curious investor. Disclaimer aside, let’s get on with the show.

Despite yesterday’s sell off, along with virtually everything energy related, I’ve been perplexed by how Methanex Corp. (TSX: MX | NASDAQ: MEOH) recently hit multi-year highs in an environment of super high natural gas prices. Why, you ask? As the world’s largest producer and supplier of methanol to major international markets in North America, Asia Pacific, Europe and South America, their primary feedstock (or input cost) is natural gas. A quote directly from the Methanex website states – “On an industrial scale, methanol is predominantly produced from natural gas by reforming the gas with steam and then converting and distilling the resulting synthesized gas mixture to create pure methanol.” Which made me wonder what the market sees that I don’t, or is it the market that is missing something?

My first thought was that maybe methanol prices were inelastic and Methanex could flow through all operating cost increases as long as demand was there. This doesn’t seem to be the case as witnessed in Q3/2019 when pricing for methanol was poor and the Company couldn’t cover operating costs and posted both an operating loss and a net loss for the quarter. Q4/19 would also have been a loss except for a one-time insurance recovery. Moving on to 2020, three of the four quarters also resulted in weak methanol sales pricing and net losses. Without digging a lot deeper into each and every quarterly report, this signals to me that Methanex isn’t able to dictate the sales price to end users.

Next, I thought, perhaps they have some great hedges in place such that, at least for the time being, they would make out like bandits with a low input cost and continually rising sales prices. This is getting closer to the heart of their current success. Several Methanex natural gas supply contracts include a base price plus a variable price component linked to methanol prices. It appears that there is a floor to the prices they have to pay for feedstock which is what hurt them in 2019 and 2020 but when natural gas prices are ripping, like they did in late 2021 and again recently, they are far less likely to get caught in a supply crunch and have to pay spot pricing for their feedstock.

It’s all good, Methanex should be a great investment in a rising price environment, case closed. Or maybe not. After digging a little deeper through their financials, I found this gem under Cash Costs: “We apply the first-in, first-out method of accounting for inventories and it generally takes between 30 and 60 days to sell the methanol we produce or purchase. Accordingly, the changes in Adjusted EBITDA as a result of changes in Methanex-produced and purchased methanol costs primarily depend on changes in methanol pricing and the timing of inventory flows. In a rising price environment, our margins at a given price are higher than in a stable price environment as a result of timing of methanol purchases and production versus sales. Generally, the opposite applies when methanol prices are decreasing.”

Based on this, it appears they could be setting up to have a disappointing quarter in the future, albeit still profitable. I doubt it’s Q1/22, given the price of everything commodity related is rising due to the fallout from Putin’s insanity in Ukraine. However, if cooler heads prevail, hopefully, sooner than later, Q2/22 could prove to be somewhat disappointing to Methanex investors when natural gas prices either stop going up or even turn around and start to fall and this cash cost lag takes a bite out of EBITDA and Net Profit.

Another potential tailwind that becomes a headwind is that Methanex doesn’t suffer from supply chain issues as they own the world’s largest methanol ocean tanker fleet. This helped make them the supplier of choice for the methanol market when the rest of the world was watching boats get stuck in the Suez Canal. With that said, we all know that there aren’t any EBs out there right now so transportation costs will be rising quickly and sharply. This could turn the tide, so to speak, on something investors have been giving Methanex a market premium for when the world was fraught with supply chain issues but becomes a proverbial boat anchor as increased shipping costs hit hard.

Lastly, and this isn’t just Methanex but every commodity producer, is demand destruction. I definitely don’t know enough about methanol uses but like everything, at some price consumers will try and find a cheaper alternative or go without if they can’t, in turn, pass along the increased costs to the ultimate consumer. Approximately 45% of global methanol demand is in the energy sector including direct gasoline blending, marine shipping fuel, and biodiesel. We’ve seen historically the impact an oil price of $130/bbl can have on demand, so I think one has to be overly optimistic to think methanol sales volumes will be unimpacted by rapidly rising prices. Albeit, demand destruction takes time, but I think this also potentially lines up for the Q2/22 results.

So, what does it all mean? I feel like Methanex might be priced for perfection right now. This latest quarterly earnings season saw some of the biggest moves I’ve seen in my life on disappointing results and/or forward guidance. If a stock isn’t absolutely perfect every quarter, it can get a big haircut in very short order. Keep that in mind if you are long or thinking about going long Methanex.

What a week! Last Thursday, Russia invaded Ukraine. Then this week global supply chains went crazy, with skyrocketing price moves and a global-scale sense of worry about where it all leads.

I won’t dwell on war news, meaning stories and imagery from front lines. It’s tragic and painful to witness, and no doubt you follow events.

But definitely, it’s worth discussing the economic impacts of the war. In particular, consider the almost immediate commercial isolation of Russia that’s now taking shape with a wide array of sanctions on Russia’s government, her banks, businesses and people.

This is an entirely new page for the world economy. And what’s happening is not as easy as just saying, “Russia is bad so let’s punish her.” Sad to say, though, that’s where much thinking across the world is focused. Do something. Make it fast. Think about it later.

Another way to say it is that Russia is a major, global-scale source of key energy and industrial resources. These range from products straight from the well like crude oil and natural gas, to refined hydrocarbons like gasoline, diesel and chemicals. Plus, Russia produces a vast array of industrially critical elements, again ranging from ores and concentrates to highly refined and processed alloys.

For example, as Russian sanctions kicked into play over the past few days the price of oil pulled up into a strong climb, with Brent Crude hitting $114 per barrel at one point. This reflects market uncertainty over future access to Russian exports. Meanwhile, one sees stories of tanker-loads of Russian oil going “no bid” because traders are uncertain about the legality of even making an offer. It’ll sort out, more or less. But for now, it’s a serious mess.

Other important commodities with a Russia-trade angle are also rising in price. Wheat futures are soaring to two-decade highs, according to market tracking services. And lumber futures are up sharply as well, reflecting concern over diminishing Russian supply.

Other materials rising in price include aerospace-grade aluminum, now at record levels according to a market follower with whom I spoke earlier. Meanwhile, a significant fraction of the world’s aerospace grade titanium – about 60% by some calculations – comes from Russia.

Or consider spot prices for other widely used, critical industrial elements like copper, nickel and uranium. All have a strong Russia supply angle, and all are at 10-year highs, per trading data.

You get the picture, right? Literally, overnight, anti-Russia sanctions have created uncertainty over future supplies of key energy resources and metals.

Meanwhile, share prices for important Russian producers have collapsed. Consider just two key companies in the Russian investment space, gas producer Gazprom (OTC: OGZPY) and metals producer Norilsk Nickel (OTC: NILSY). Both companies’ share prices have tumbled in recent days, as you can see here:

Is there an investment angle? Well, the possibilities are many and depend on your risk tolerance.

For the truly bold, the collapse of Russian share prices creates a contrarian setup. If you are aggressive, and perhaps a bit crazy, feel free to wade into the selloff and buy shares of Norilsk and Gazprom. Of course, we don’t yet know what will happen as events unfold, so the “buy low” idea could also lead to even more losses, of not a complete wipeout. You’ve been warned.

Or frame it this way: Russia now has a very significant level of what’s called “war risk” in everything that has to do with its investment climate. Perhaps there’s an upside in the not-too-distant future, but for now the entire space is a very dangerous place to be for most investors.

The safer investment idea is to focus on U.S. and Canadian names that work in the resource space that’s affected by Russian sanctions. Of course, there are many names out there ranging from small exploration plays to large and mighty companies.

For example, let’s look at nickel. Large nickel producers include Brazilian play Vale (NYSE: VALE), as well as Swiss-based Glencore (OTC: GLNCY) and Australia’s BHP Group Ltd. (NYSE: BHP). These names have global operations and everything you would want in a major player. If customers need nickel and cannot obtain it from Russia and Norilsk, they can buy it from these other guys.

On the much smaller, exploration side, though, my strongest play is a Canadian junior operating in Montana, called Group Ten Metals Inc. (TSXV: PGE | OTCQB: PGEZF). This company is relatively early stage in its efforts, but with significant progress on the books. The play is focused within the well-regarded Stillwater District, where the company holds a massive land package. Exploration has already revealed extensive mineralization in copper, nickel, platinum, palladium, rhodium, gold, silver and even chrome. It’s a superb asset (I’ve visited the site and seen the mineralization), with strong technical and management talent.

It’s also worth noting that Group Ten holds lands directly adjacent to Sibanye-Stillwater, Ltd. (NYSE: SBSW), currently producing minerals in the region. This situation makes it more likely that Group Ten can eventually obtain necessary mining permits and move towards development and production.

To sum up, we can’t do anything about the tragic war in Ukraine. Meanwhile, the anti-Russia sanctions are a massive, international phenomenon, again out of our hands. But already these dynamics have set up severe supply chain issues, all based on just a few days of history being made. And more disruptions are, no doubt, in the pipeline as events unfold and politics play out.

Finally, looking ahead the world is not simply on a glide path to a new version of the Cold War. No, Western nations are on the path to a “Commodity War” scenario, firmly embedded inside the looming political, economic and perhaps military confrontations. In this sense, holding real assets – including ores in the ground – is critical to your investment future.

On that note, I rest my case.

That’s all for now… Thank you for reading.

Best wishes…

Byron W. King

Geopolitics are currently front and center in the news stream. I won’t even pretend to know what the true end game would be for Russia. It could be to annex more of Ukraine or perhaps even fully occupy the country. Putin is a very savvy and aggressive statesman, and I suspect there may well be a game within a game within a game. We may never be made aware of what the final strategic outcome is, we will only ever hear what we are either allowed to or intended to hear from the various spin doctors on all sides. Whatever the outcome of this, and many other simmering political events, security of resource supply has to be a front and center part of your decision making as an investor.

This week we are going to talk about the uranium supply. Granted Russia only mines approximately 6% of global supply and Ukraine only produces a little over 1% of global supply, the implications for the uranium market could be a little more dynamic than the simple supply picture. If you recall a few weeks back there was plenty of political unrest in Kazakhstan, the largest global supplier of uranium at roughly 40%, and who was there to send in troops to help quell the protests and support the government – Russia. It’s not a huge leap (at least in my opinion) to envision a scenario where Russia puts it’s 100,000+ troops and the supplies it’s been building up for over a year on the Ukraine border to use in some way. In turn that would likely lead to sanctions of various shapes and sizes that could very easily cause another level of back-and-forth brinksmanship, whereby Russia calls on its ally Kazakhstan to return a favor and make life difficult for the world’s largest consumer of uranium – the United States.

Perhaps I have too much time on my hands to think about these kinds of things, or maybe I read too many novels with sensational plots. Nevertheless, one has to think that the largest consumer of uranium might be working on things in the background to secure supplies of this commodity from slightly more friendly allies. Especially given, according to the EIA, that in 2020 the U.S. purchased 22% of its uranium from Kazakhstan and 16% from Russia. So where better to support development and supply than your friendly neighbor to the North that just happens to host the world’s richest uranium play – the Athabasca Basin. I guess your own backyard would be another logical place but I’ll save that for later in the week.

As an investor, it’s likely the first place you’d look is the existing Athabasca producers like Cameco Corp. (TSX: CCO | NYSE: CCJ) and Denison Mines Corp. (TSX: DML | AMEX: DNN). But if you want real leverage to my potential escalation scenario, it’s the junior names that could give you the big moves. At the top of my list for junior explorers in the Athabasca Basin is Fission 3.0 Corp. (TSXV: FUU | OTCQB: FISOF) a uranium project generator and exploration company that currently has 16 projects in the Athabasca Basin. This is the third generation Fission run by one of Canada’s leading uranium exploration teams, which has already had success in the region including an asset sale to a major producer. The Company’s management, headed up by Dev Randhawa as CEO & Chairman, is part of the team that founded Fission Energy Corp., which made the J-Zone high-grade discovery in the Athabasca Basin and built Fission into a TSX Venture 50 Company, which sold the majority of its assets to Denison Mines in April 2013. Fission Uranium Corp. (TSXV: FCU | OTCQX: FCUUF) was founded by the same team, including uranium expert Ross McElroy, which made the Patterson Lake South high-grade discovery. Mr. McElroy elected to stay with FCU to focus on the development of the Triple R deposit at Patterson Lake South but remains on Fission 3.0’s Board of Directors and remains as the Company’s QP.

Several of Fission 3.0’s projects are near large uranium discoveries, including the Arrow, Triple R and Hurricane deposits. At the end of December Fission 3.0 completed an C$8.6 million financing with an additional C$690,500 raised from the exercise of warrants to go along with the C$9.3 million the Company finished Q3/21 with. This leaves the Company well-funded at year end to continue its aggressive winter exploration/drill program on its Patterson Lake North project, which mobilized January 10^th. Plans include a 4,000m seven-hole winter drill program focused on the previously untested Broach Lake and N Conductor targets.

Fission 3.0 has lots of cash in the bank and plenty of targets to drill, which should make for an exciting few months regardless of what happens in the rest of the world. With a market cap of approximately C$41 million, there is still plenty of upside to be had if this successful team can find yet another world class uranium resource.

As Russian troops gather at the Ukraine border a war looks imminent. U.S intelligence has warned that Russia is likely to invade Ukraine as early as this week. Investors can look at ways to protect and position their portfolio if the Russian invasion goes ahead, as is widely expected.

Based on the February 27, 2014, Russian invasion that took control of the Crimean Peninsula from Ukraine, any invasion may meet with limited resistance. The 2014 invasion and takeover of Crimea was completed in only a month. Of course, on this occasion the whole of Ukraine is at risk and the Ukrainian military response should be a lot greater.

Russia and Ukraine look to be on the brink of war

Source: iStock

Sanctions on Russia will likely be the key response from the West

If Russia invades then the most likely outcome is that very heavy sanctions will be imposed on Russia by at least the U.S, UK, and the European Union. Goods and services likely to be sanctioned could be the import of any military hardware & software, semiconductors, smartphones, critical metals etc. There would also likely be financial sanctions that act to block western finance to Russia and Russian companies as well as US dollar transactions. Russian exports (with gas and perhaps oil excluded) may also be sanctioned, which could lead to price spikes in key commodities and metals (palladium, iron ore, nickel, aluminum, or uranium) that Russia exports. For example, the Russian company Norilsk Nickel is the world’s leading palladium and nickel producer; the Russian company Rusal is a large global aluminum producer; and much of the world’s uranium comes from Russia, and Russian controlled companies such as those operating in Kazakhstan.

Ukraine would also be heavily impacted by a Russian invasion, which would interrupt Ukrainian businesses. Ukraine is well known for its fuel and non-fuel resources production and mining industry, including natural gas, oil, coal, iron ore, chalk, limestone, and manganese ore. Manufacturing is also a major business in Ukraine and includes automotive, shipbuilding, aircraft & aerospace. Ukraine is also a strong agricultural producer that helps to feed Europe. Key Ukrainian agricultural products include corn, wheat, sunflower oil, sugar, dairy, meats, honey, and nuts.

Ways to protect your portfolio

Some of the safe havens in times of conflict include:

• Cash (U.S dollar, Japanese Yen, Swiss Franc).
• U.S Government bonds.
• Physical Gold, and quality gold producing mining companies.
• Rotating some money out of risky assets.
• Reducing exposure to Europe.

Possible winners if Russia invades Ukraine

• Global energy companies due to increased price of oil and gas. Leading non-Russian gas and oil companies include Exxon Mobil Corporation (NYSE: XOM), BP plc (NYSE: BP), and Chevron Corporation (NYSE: CVX).
• Global metal companies (palladium, iron ore, nickel, aluminum, uranium). For palladium consider South African Sibanye Stillwater Limited (NYSE: SBSW). For iron ore and nickel consider Brazil’s Vale S.A. (NYSE: VALE), or Australia’s BHP Group Limited (NYSE: BHP). For aluminum consider China’s Chalco (SHA: 601600) or America’s Alcoa Corp. (NYSE: AA). For uranium consider Energy Fuels Inc. (NYSE American: UUUU | TSX: EFR) or Ur-Energy Inc. (NYSE American: URG | TSX: URE).
  
• Military related stocks as the West supports Ukraine and other parts of Europe with access to the latest weapons as a counter to Russian expansion in Europe. Consider the iShares U.S. Aerospace & Defense ETF (ITA) or the more aggressive Direxion Daily Aerospace & Defense 3X Shares ETF (DFEN). More details on the top defense stocks in my recent InvestorIntel article are here.
• Agricultural stocks. Given Ukraine is a food bowl of Europe, then any significant disruption to the Ukraine agricultural sector could force up prices for grains such as corn, wheat, and sunflower oil.
• Cybersecurity stocks may be a winner if Russia responds to the West with cyber-attacks. Consider buying the ETFMG Prime Cyber Security ETF (HACK).
• Inverse or Bear ETFs that short the market or the currency. As there is no current Russia short ETF (Direxion Daily Russia Bear 3x Shares (RUSS) ETF closed in 2020) or short Russian ruble ETF to my knowledge, one option would be ProShares Short Euro (EUFX) or ProShares UltraShort Euro (EUO) for shorting the Euro currency. These are only suited to day trading and sophisticated investors.
• Shorting individual Russian stocks.

Possible losers if Russia invades Ukraine

• Russian ruble currency, Ukrainian currency (the hryvnia).
• Russian stocks and the Russian stock market index (eg: iShares MSCI Russia (ERUS)).
• Companies that have significant exports to, or revenues from, Russia as Russia may impose countersanctions or suffer a sharp slowdown. Examples include Veon (NASDAQ: VEON), Mobile TeleSystems (NYSE: MBT), EPAM Systems (NYSE: EPAM), Playtika (NASDAQ: PLTK), QIWI (NASDAQ: QIWI), and Ozon Holdings (NASDAQ: OZON).

Closing remarks

When Russia invaded Ukraine in 2014 the immediate impact saw the Russian stock market index fall ~11%, European stock indexes fell (Germany fell 3.3%), and the Russian ruble fell to a record low. US shares fell about 1.3% and money flowed into US bonds, gold and safe haven currencies. Rotating some funds from risky assets into safe havens right now looks to be a good idea.

Apart from what’s mentioned in the article, investors should also consider using any significant dip in global share markets as an opportunity to buy, as any contained Russia/Ukraine conflict should not have a lasting impact on the world. I will most likely use any market dip to top up on some of my favorites such as Alphabet Inc. (NASDAQ: GOOG) and Tesla Inc. (NASDAQ: TSLA), as well as some well valued EV metal miners.

Finally, there is also the risk that Russia backs down or de-escalates and we get no Ukraine invasion. In that case, most of the stocks and ETFs in this article are likely to fall back after a recent run up as invasion risks have been an issue for some months now.

At the rate of escalation, we should know what the outcome is probably within the next month or two. Feel free to post your thoughts and idea in the comments section below.