As we mark the somber first anniversary of Russia’s invasion of Ukraine, I thought it would be interesting to have a look at what equities have been impacted by this brutal and very unnecessary war. My first thought was that defense or drone stocks would be slam-dunk outperformers. I also figured there would be several resource companies that may have done well if they produce key commodities where Russia was a dominant player, assuming the company in question wasn’t actually operating in Russia where it likely would have had to forego its assets. What I found surprised me.

Defense and Drone Companies

I first looked at the biggest U.S. defense and drone stocks and did not find what I expected at all. Let’s start with Raytheon Technologies Corporation (NYSE: RTX), and Lockheed Martin Corporation (NYSE: LMT) because not only are they two of the largest market cap defense contractors (US$145 billion and US$122 billion, respectively) but they also count as two of the biggest manufacturers of military drones. Excluding dividends, Raytheon is actually down 3.5% over the last year, while Lockheed Martin rose 10.5%. Granted a positive 10.5% return over the last year did materially outperform the S&P 500, which was down 9% over the comparable time period, I was expecting a much better return.

Given the ever-increasing use and impact of drones in Ukraine, I thought I’d look at a company that was almost exclusively focused on this sector alone to see if there was any difference in performance from the multi-faceted defense names. I choose Kratos Defense & Security Solutions Inc. (Nasdaq GS: KTOS). Not only because of the name but the Company has contract ties to the U.S. Department of Defense, and roughly 25% of Kratos’ revenue comes from its “Unmanned Systems” division. This all sounds good on paper but the Kratos share price saw a dismal 40% loss over the last 12 months. Even with that pummeling, Capital IQ has the stock trading at 33.2x Forward P/E. I don’t think I’ll be putting this name on my list as a hedge against the war in Ukraine dragging on for a lot longer.

(Note: An Unmanned System (US) or Unmanned Vehicle (UV) can be grouped into four primary types: (1) in the air, as Unmanned Aerial Vehicle or System  (UAV or UAS), commonly known as a “drone”; (2) on the ground, as Unmanned Ground Vehicle (UGV); (3) on the water surface, as Unmanned Surface Vehicles (USV); and, (4) in the water, as Unmanned Underwater Vehicles (UUV).)

Commodity Stocks

Time to change gears and start looking at commodities. Despite oil, natural gas, and refined products accounting for Russia’s largest value of exports, I chose platinum as the first place to look given Russia’s Norilsk Nickel (MISX: GMKN) accounts for 10-12% of the world supply, which is a higher percentage of global market share than oil or natural gas. For reference, Nornickel, as it is also known, is also the world’s largest palladium and refined nickel producer, plus a top-ten producer of copper as well. The best platinum/palladium surrogate I could find was Sibanye-Stillwater (NYSE: SBSW), another of the world’s largest primary producers of platinum and palladium. This stock is down an abysmal 57% over the last 52 weeks. With platinum prices down 10% year-over-year and palladium down 41%, it appears the market isn’t reeling from the impact of Russian supply disruptions in these particular metals.

Early in the conflict, natural gas was making a lot of headlines, with European prices spiking to unimaginable heights and all the subterfuge around the two Nord Stream pipelines. The leading European benchmark is Dutch TTF Gas and it is priced in Euro per megawatt hour (€/MWh). Despite this benchmark price peaking in late August 2022 at €339, it is currently trading below €50, even lower than it was trading before this whole mess began. Meanwhile, Henry Hub gas prices in the U.S. also peaked in August at US$9.71/MMbtu (Metric Million British Thermal Unit) but iscurrently transacting around US$2.70, also below year-ago levels. Thus, it will probably come as no surprise that big natural gas producer ARC Resources Ltd. (TSX: ARX) in Canada and EOG Resources, Inc. (NYSE: EOG), a leading gas producer in the U.S., are trading at pretty much the same price they were last year at this time. Or maybe it is a surprise as one might think they’d be down year over year based on the commodity price.

Oil and Refined Products Companies

The question is, did anyone’s share price benefit from this unfortunate event? There were a few that I found and they were all oil and refined products related. The most well know name of the bunch is Exxon Mobil Corp (NYSE: XOM) which returned an impressive 41% excluding dividends over the last year. We all know Exxon is a behemoth, and there could be lots of reasons other than Russian supply disruptions that could have influenced the share price but other integrated global giants like Shell PLC (formerly Royal Dutch Shell) (LSE: RDSA | NYSE: SHEL) and BP plc (LSE: BP | NYSE: BP) all had similar one-year performances. Albeit they all had setbacks of some form in the last year due to the fact that they had to write off or choose to sell (for essentially zero) some Russian assets. Regardless, the large integrated oil companies outperformed the rest of the sector for the most part.

Tanker Stocks

But the big outperformers were the oil and refined product tanker stocks. The returns in this category were what I would have expected from the defense stocks, which as we discussed above, were relatively disappointing. There are many to choose from but I looked at two that I have traded in the past but did not have the foresight to continue holding them. The first company is Scorpio Tankers Inc. (NYSE: STNG), a Monaco-based international transporter of refined petroleum products with a fleet of 113 vessels. This stock returned a whopping 255% over the last 12 months.

The second company is Frontline Ltd. (NYSE: FRO) a Bermuda-based company providing marine transportation of crude oil and oil products with a fleet of roughly 70 tankers. Frontline returned 97% excluding dividends since the end of February 2022. This quote from Scorpio’s Q4, 2022 results pretty much sums up why this sector has performed as well as it has:

“…the volatility brought on by the ongoing conflict in Ukraine, which has resulted in the implementation of sanctions on the export of Russian crude oil and refined petroleum products, has continued to disrupt supply chains for crude oil and refined petroleum products, changing volumes and trade routes, and thus increasing ton-mile demand for the seaborne transportation of refined petroleum products.”

Scorpio’s Q4/2022 vessel revenue increased 211% as a result and needless to say, the market paid attention even though I did not.

Today I’ve only scratched the surface of what ramifications the Russian invasion of Ukraine has had on markets and stocks around the world. What I truly hope is that I won’t be doing this again a year from now.

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.

If you follow war news from Ukraine, no doubt you’ve seen gruesome images of wrecked tanks, burnt trucks, demolished personnel carriers and more.  

Whether it’s Russian or Ukrainian equipment, almost everything you see is based on old Soviet-era designs such as T-72/64 tanks, or boxy BMP armored vehicles, etc. And when a rocket or shell hits those things the internal fuel and ammunition cooks off, and the machines burn like a torch. Bad design, obviously. 

But there’s another Russian weapon that was also recently deployed, and it appears to be working very well. You won’t find this system on the battlefield, though. In fact, this Russian device is an economic weapon, and it may prove to be one of the most impactful implements of war in the modern age.  

That is, the government of Russia recently pegged that country’s currency – the ruble – to gold. And right now, Russia’s central bank will buy gold at 5,000 rubles per gram through June 28. (After that, we’ll see.) 

Here’s why this is important. Russia has just established a state-supported bid for gold. In essence, Russia has recreated a new global gold standard with a well-defined floor beneath the price. This is big. It moves the gold price, and I mean upwards. Why? 

On the day that Russia set the bid at 5,000 rubles, the dollar-ruble exchange rate translated to gold at about $1,550 per ounce, or well below the London daily quote. No big deal, right? Well, not just then, not at that time. 

But something else happened. Within days of the Russian announcement of rubles for gold, the Russian currency strengthened firmly against the dollar.  

Today, about two weeks after the initial announcement, those same 5,000 rubles per gram translate to a gold price of about $1,925. Which is about what the London quote is.  

In other words, Russia’s hard fix of rubles for gold has equilibrated with the dollar-ruble valuation. Meaning what? 

Well, look at it this way: Russia has just undermined the ability of “paper” gold traders to sell the metal down too far, lest the spread open and arbitrageurs swoop in. 

Got that? With a Russian price floor beneath gold, there’s high risk to downside trading.  

Very clever. Russia has not gone out and simply bought gold contracts with the intent to corner the market, eventually present them for delivery, demand physical gold and basically “break the bank” in a strict sense. Nope. No brute force, like rolling a tank into town. And more than likely, if Russia had done that then the gold exchanges would have found some way to dishonor the underlying contracts and blame it all on “sanctions” or such. “No gold for you, Ivan!” 

In this instance though, Russia has been quite subtle, offering to buy gold at prix fixe. And in this manner, Russia has created a new economic playing field across the world. It’s currently embryonic, but there’s no denying that it’s a parallel platform to the dollar-dominated regime that has lasted since World War II.  

We now have a new scenario, though; a gold-backed floor price in which even the world’s most aggressive gold traders and market makers cannot sell the metal down, lest they fall into their own trading trap.  

But at this point it’s fair to ask, what makes this Russian ploy work? How will it be effective? 

In the introductory phase, the success (or not) of Russia’s gold gambit hinges on the country’s exports of natural gas. That is, Russia has told all buyers that it will sell its gas to “unfriendly countries” only for rubles.  

In essence, this segregates buyers. Everything is based on their political stand regarding Russia’s Ukraine military operation. More practically for the nations of Europe, Russia will accept no dollars or euros for gas, just rubles (or gold of course). And suddenly, literally within a matter of days, many gas buying nations must come up with a whole lot of rubles. 

Looking ahead (and recall that June 28 date above), it’s more than likely that Russia will announce sale of oil in rubles, which matters when that news comes from one of the world’s top three oil producers. And then there are Russia’s exports of minerals, agricultural products and pretty much everything else.  

If you add up Russia’s exports of gas, oil, minerals, ag and other things – weapons come to mind – the overall value is in the range of half a trillion dollars per year. Now translate all that into rubles, and it’s a lot of currency exchange banking.  

Or translate that cumulative dollar-total of Russian exports into gold at 5,000 rubles per gram, it makes for a lot of gold.  

Right now, across the world people, companies and nations that hold dollar reserves are still mentally processing this new state of monetary affairs. And there’s much to process, considering the general lack of appreciation towards gold in modern Western monetary thinking. Plenty of disdain, actually.  

So, we’ll see. And recall that old saying, “Wisdom may come late, but it seldom never comes.” Meaning that sooner or later, people will figure out that if they want Russian gas, oil, minerals, food and much else, they will have to fork over the rubles. And many dollar-holders will then lighten up and sell bucks to buy rubles, as well as buy physical gold. 

One way or the other, we will witness the dollar weaken, perhaps a little bit and slowly, or maybe a lot and fast. While the ruble will likely strengthen, which means that the dollar-ruble exchange rate will tighten.  

At the end of the day, the dollar-price for gold will rise, and along with that the valuations of many gold mining companies will move upside. Heck, we may even see a meltup in the price of gold, and an investor panic into gold miners across the entire sector, from juniors to established biggies.  

Here’s the takeaway. Russia’s central bank will pay 5,000 rubles per gram of gold, and this sets a hard, new price floor. The dollar-ruble rate has tightened, and Russia has now created a new gold standard for the world, backed by its natural gas if not its oil, minerals, agriculture and other exports, all under cover and protection of Russia’s well-known nuclear weapons complex.  

It’s worth noting that Russia has been planning this move for many years (with China in concert, more than likely). All of this didn’t just sort of happen. But here we are, and it’s not the time or place to recriminate. 

Predictions: Gold-backed rubles will strengthen. While ongoing inflation trends in dollars will weaken the U.S. currency. All this while few people in the West truly understand the basic idea that “gold is money.” 

A new, worldwide economic education process is about to begin. Time to brush off those century-old books about the “gold standard.”  

And however crummy those Soviet tanks and armored vehicles might be in the midst of modern war, the price of gold and gold miners is on the way up.   

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

Best wishes…   

Byron W. King  

In a recent InvestorIntel interview, Tracy Weslosky spoke with Christopher Ecclestone, Principal and Mining Strategist at Hallgarten & Company about the impact of the Russian invasion of Ukraine on the resource market.

In this InvestorIntel interview, which may also be viewed on YouTube (click here to subscribe to the InvestorIntel Channel), Christopher Ecclestone pointed out that Russia produces a lot of minerals and metals, but that it is a key producer of critical metals like nickel, cobalt, platinum and palladium. Explaining how Russia is currently being cut off from global markets, he went on to highlight the disruptions in platinum and palladium supply given that Russia is among the largest producers of those metals. Christopher went on to discuss the impact of the European conflict on the rare earths sector and on the Canadian resource companies with Russian investment.

To watch the full interview, click here.

About Hallgarten & Company

Hallgarten & Company was founded in 2003 by the former partners of a well-known economic think-tank. Their output encompasses top-down and bottom-up research from a Classical Economic (Austrian School) perspective. Over the years, the team has successfully picked trends using macroeconomic underpinnings to guide investors through the treacherous waters of the markets. It was only natural, in light of the focus of Classical Economics upon the “real value” of monetary assets that the firm’s strengths should ultimately have become evident in resources sectors and projections of commodity trends.

Hallgarten & Company has advised and managed portfolios of offshore and onshore hedge funds.

Hallgarten also provides consultancy services on Latin American economic, politics and corporate matters including the production of bespoke research.

Hallgarten research is now available on Bloomberg and FactSet.

To learn more about Hallgarten & Company, click here