Even if the conflict in Ukraine comes to a conclusion, it is unlikely that western sanctions on Russia will be rolled back. Therefore, investors may seek to address the realities of this new world order via a shift in capital allocation to natural resources and energy.
- Western producers will have to step up and fill Russia’s energy export gap as well as agricultural export losses from Ukraine. We believe that this adjustment to recover supplies could take as long as two years. With this realization, the futures price of oil and other commodities has shifted higher not only in the near term, but in the longer term as well.
- In the US, crude oil production has finally started to rise at a double-digit pace. Higher oil, gas, and agricultural commodity prices will incentivize further production gains. This will slow inflation later this year, but not before US consumer prices surge further. A consumer-harming spike to 8.5% US inflation in the next 3 months is most likely. This would send US gasoline prices perhaps 20% higher by early Spring.
- The Fed intends to tighten into this shock but has no true influence over the supply recovery needed to stabilize consumer prices.
- The yield curve has been flattening on rising recession risk with real interest rates still likely to decline further as prices spike. The plunge in bond yields should (partly) reverse if and when global producers/exporters rise to fill the hole from Russia’s departure.
- Prior to the shocking events in Ukraine, it was already clear that a transition from fossil fuels to renewables required significant supply redundancy to avoid damaging price spikes. If Russian oil and gas output is lost, not a single additional net unit of carbon would be emitted to replace it.
- An unfolding, painful jump in crude oil and natural gas costs will incentivize investments in alternatives. At the same time, US oil field services firms and much broader global natural resources firms are likely to see an improved profit environment for the coming two years, even when
crisis peak prices(perhaps oil in a $125-$150 level near-term) are not sustained.
- With this, we are contemplating significant portfolio shifts within our equity allocations toward natural resource producers and away from consumer-sensitive equities within and across regions. However, shifting our portfolios toward higher return potential opportunities in energy and commodities will come at the expense of other sectors of the economy and regions of the world.