A Monetary Earthquake
The financial and geopolitical happenings of the last two weeks are enormously important to our current financial system and misunderstood by many investors but for a few astute analysts.
The Russian invasion of Ukraine, corresponding Western sanctions and attempted seizure of Russian FX reserves are nothing short of a monetary earthquake. The last comparable event was Nixon’s abandonment of the gold window in 1971 (pesky French were to blame for that one). Russia, with the backing and support of China, just told the world that it is no longer going to sell its oil, gas and wheat for Western currencies which are programmed to debase.
The West in its response just said to all countries around the world: “If you have foreign exchange reserves, held in our system, they are no longer safe if we disagree with your politics.” Whilst this may seem appropriate action to take against a country that has just invaded another sovereign, the reality is Putin was ready for this move and many of the others the West has made so far.
Ready by way of the chart below. A little gold heavy, more on this down the page.
The bigger issue this geopolitical event raises for investors is, can the West and its financial system survive in its current form without Russian oil and gas? How severe will the knock-on inflation/recession effects be?
Another question that has been on our lips since at least 2008 is, can the financial system change from its current US petrodollar hegemony without a war? Changes of such magnitude rarely happen without the backdrop of major conflict. Bretton Woods in 1944, Nixon’s Gold window closure in 1971 are but two examples.
But before we delve back into energy related systemic issues let’s have a look at some of the damage of the last few weeks. Russia is an enormous grain producer (not to mention Palladium where Russia accounts for 40% of global production). Together Russia and Ukraine account for 25% of global trade in wheat and 20% in corn. Also, where might fertilizer prices end up under the current backdrop?
European Banks down 34% in a month matters.
Gold and Silver. Things are only just getting started?
And in a nod to the ghosts of 2008, how about MARGIN CALLS on commodity collateral, check out the form of Nickel below. Nickel exploded 82% in one day amid a wave of short squeeze in the largest dollar gain in 35 yr history of LME contract…
The reason for the short squeeze of such magnitude is leverage, of course!
From Zerohedge: “Around the time Peabody was served with a $534 million margin call on its hedging coal futures short, which it funded with a new $150MM unsecured (10%) revolver from Goldman Sachs, one of China’s largest banks was also served with a margin call for hundreds of millions of dollars on a nickel short gone terribly bad after the price of Nickel did, well, what it did above.
And so, as we wait for more massively short squeezed names to emerge in other sectors, we can’t help but wonder if this is precisely the start of the “liquidity crisis” predicted by Zoltan Pozsar; after all, he has called virtually everything else spot on so far…”
Markets are breaking down.
As it is with most financial crisis in a financialised world chock full of debt and derivatives, we’ll only know who is swimming naked when the tide goes out, and it is going out. This war thing has only intensified the same brewing economic themes we’ve been commenting for many a year, just go back to our “get set” note from January.
The Russian invasion of Ukraine has only quickened the already shifting plates of an ageing financial system. Even an average investor knows energy prices were rising well before the Russian invasion. The same average investor knows that inflation moved from “transitional” to whatever it is now back in early 2021!
On the topic of energy and inflation, the energy complex is at the heart of this geopolitical and economic malaise. Russia has stood back and watched the World Economic Forum Davos types virtue signal on climate change for years.
We don’t think even Putin himself would have ever dreamed that the West’s woke lunatic ESG policies would lead to it shooting itself in both legs by trying to cut off hydrocarbon supply and replace it in a ridiculously short timeframe with wind and solar!!
Anyway, the reality is, as the West is busy cutting itself off from Hydrocarbon (and nuclear) production it now loses Russian Oil and Gas supplies.
It really makes one think, if one had a neighbour from whom one would import 40% of its natural gas requirement, one might consider treating him with a little more respect than our Western European governments treat Russia. The willingness to include Ukraine into NATO was a blatant provocation, which the European leaders should have avoided contrary to US pressures.
That the US hates Putin and Russia for some reason has been obvious for some time as is the case for China. Whatever goes wrong in the US, it’s either caused by Mr. Putin or Mr. Xi Jinping. In fact, now the US can blame inflation on Russia and the Fed can postpone meaningful interest rate hikes due to the prevailing tensions, which it will do.
In fact, as per the chart below, The Fed has been mostly only jawboning rates for many years anyway. It knows rates cannot move meaningfully, the math on higher interest rates with such public and private commitments don’t work.
You hearing this? Rates won’t go up (cause of “Putin” …LOL).
Back to the seismic shift in in the financial system, now accelerating as a result of the US sanctioning Russia’s FX reserves. The promise of interest rate rises, as demonstrated by the chart above have helped keep the US dollar from feeling too much pressure over the last year (as well as keeping Gold down). Markets have incorrectly believed the Fed when it said it would raise rates to combat inflation. If the US Fed raises rates moving into the current recessionary and inflationary environment this month, IT WILL BE THEIR LAST.
More than likely they will hide beneath the blanket of war with a pause. Then what are we back to? QE, money printing? More of the same? You Bet. More cowbell. https://www.youtube.com/watch?v=TklM2-lSby4
How do you think FX markets will treat the US dollar then, after being promised rate rises for the best part of 12 months! More to the point, how will other countries that have been willing participants in the US paper markets react, particularly now the US is willing to sanction FX reserve paper?
They’ll stop buying. This has already been happening slowly over the last 12 years anyway as the world wakes up to the perilous state of US finances and commitments and the potential knock on currency effects.
Who will then step up to fund the massive deficit spending and social commitments of the US govt? The Fed of course. The die is cast and many Governments started to prepare years ago. This has been evident in many Central Banks continuing to accumulate AND REPATRIATE Gold over the last 10 years.
The financial system is in need of some new bedrock, to replace the failing US petrodollar bedrock of the last 40 years. The beneficiary may well be Gold and other strategic commodities, as we’ve been saying for years.
There also appears to be a quickening of reform in the paper/derivative gold complex, even though new watered down BIS Basel rules discouraging large unbacked derivative “shorting’ by major banking institutions have proved little deterrent, so far.
It’s at this point one should note that the average bull market for gold over the last 50 years has been a price increase of 7 to 8 times from its bear market low. If we go back to the most recent December 2015 bear market low for gold at $1050… well, you do the math.
Peace.
