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Conflict and commodities: the effects of the Ukraine/Russia conflict on financial markets

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It’s been just over a month since Russia moved its forces into Ukraine, but already Vladimir Putin’s actions have had a colossal impact on the global political and economic landscape. Indeed, in the face of perhaps the largest armed conflict in Europe since 1940, one might assume that the markets would also be feeling the repercussions of conflict. But oftentimes, war behaves in inexplicable ways, both on the battlefield and in the stock market.

In the past, it has often been the case that stock markets are relatively unaffected by moments of geopolitical conflict. In 2017, both the bombing of Syria and the North Korean Missile crisis were reflected rather mildly in the markets. A more extreme example outlining this reaction is the fact that the Dow was up a total of 50% during World War II. As sad as the human cost is at moments of history like these, traders and investors would be forgiven for inferring that the markets can be heartless in the face of geopolitical turmoil. Now, the question is whether the markets will react in kind to this specific conflict.

Indeed, the West has placed unprecedented sanctions on Russian oligarchs, businesses and other key facets of Putin’s regime, and continues to do so as the crisis continues. As the Russian economy crumbles and its stock market remains closed, the Rouble has steadied somewhat, but is still hovering at 104 to the dollar. Yet the conflict isn’t just affecting the Russian economy – as businesses withdraw from Russia, in Europe oil prices continue to skyrocket, with stocks teetering on the brink of correction territory. In many ways, the great condemnation of Russia in the business world is unusual in itself, as huge global corporations and conglomerates are taking a moral stance against its actions in ways that they have not in the past.

Perhaps one of the larger market debates sparked by the conflict is whether this crisis marks a moral shift in investment trends – the likes of which we have been beginning to see with ESG funds and clean energy in recent years. Only time will tell, and for now only one thing is for sure: we can be certain that a long war can bring fresh volatility.

The effect of sanctions on energy markets

Making up 4.9% of Russia’s GDP and 40% of the federal budget, it’s fair to say that oil and gas is paying for Putin’s actions in Ukraine. Therefore, it’s no surprise that the West is scrambling to reduce Russia’s revenue from their natural resources and starve the invading force of funds.

As the U.S. and the UK only rely on Russian oil for 8% and 3% of their respective imports, it has perhaps been easier for President Biden and Prime Minister Boris Johnson to set the tone in sanctioning this aspect of the Russian economy – other countries in the EU bloc have reacted with more caution. Accounting for more than half of Russia’s total daily crude oil exports, the EU also relies on Russia for 40% of its natural gas, so any further disruption to the Nord Stream supply could be disastrous for European economies.

Indeed, the sanctions fallout has already increased energy prices to unprecedented levels. With many traders looking elsewhere for oil, Middle Eastern oil increased in demand, pushing the global benchmark for oil prices past $113 a barrel in the days following the start of the conflict – the highest since June 2014. Even with Rishi Sunak’s 5p reduction on fuel duty, prices at the pump are unlikely to improve any time soon, which will no doubt stoke already spiralling inflation even further, with levels forecast to reach 9% at the end of 2022.

So, how does this impact investors? For now, there are two lines of thought – the first being that the restrictions placed on oil and gas will prompt investors to turn to ESG funds, nuclear energy eco-friendly substitutes like biogas, low-carbon hydrogen via electrolysis, and the technologies required to produce ‘cleaner’ energy. These actions are likely in the medium- to long-term – however, another line of thought in the short-term poses that we are more likely to see an uptick to traditional fossil fuels, which could set net-zero goals back some way.

Impact on stocks

As I have already mentioned, many businesses (around 150) have pulled out of Russia for what seems to be moral reasons in recent weeks, reflecting a somewhat unusual shift in the investment world. Even the likes of Shell and BP have given up major assets in the Russian oil industry, with other huge corporations like McDonalds also halting their operations, while continuing to pay their staff in order to ease the disastrous effects of sanctions on normal working Russian people. On the flip side, companies who continue to operate, or have since restarted operations in the country, such as Renault, may face consumer backlash in the West. Going forward, it may become taboo to do business with Russia. If geopolitical tensions are prolonged, consumers may actively boycott companies who continue to operate in Russia, which may affect their stock valuations.

Already, the threat of Russian aggression escalating into a wider-scale conflict in both the real world and the cyber realm has caused defence and cybersecurity stocks rise sharply in value. Along with Germany’s pledge to supply Ukraine with ground-to-air missiles, the EU and the Biden administration have also promised to increase their defence budgets. As such, U.S. defence giants Raytheon Technologies have seen their shares grow by more than 10% in recent weeks. Elsewhere, Global X Cybersecurity exchange-traded fund (ETF) rose by 3.6%. Indeed, investors can expect stocks in the defence arena are likely to continue in this direction as a result of continued geopolitical tension.

China’s ‘strategic partnership’ with Russia

Another aspect of the conflict traders and investors should look out for is Russia’s ‘strategic partnership’ with China. Indeed, since the annexation of Crimea in 2014, trade between the two countries has grown by more than 50% and increased by 35.9% in 2021 alone, with President Xi Jinping stating that the alliance is one ‘without limits’. Recent events have proven this to be incorrect, as President Biden has threatened to impose sanctions on China in the event that it supplies military equipment and weaponry to Russia. Although President Xi likely shares a similar worldview to Putin, up until now, this seems like a risk China is not quite willing to take. As the biggest importer of oil in the world, China is particularly vulnerable to market fluctuations and changes in Western trends. Indeed, the threat of businesses and investors exiting the China in the way they have in Russia should be a big enough threat to discourage President Xi, as such, it is unlikely that China will openly show support for Russia’s actions with military or direct financial assistance. At the end of the day, China looks out for China, and we could see a policy shift away from friendly relations with Putin if trade with the West comes under threat.

To briefly conclude, the armed conflict between Russia and Ukraine is a particularly unsettling moment in modern history, and it is likely that investors will be grappling with more than just their portfolio at the moment. However, keeping a clear strategy in mind is vital at times like these to ensure that traders and investors do not lose their way in the fog of war.

High-Risk Investment Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 72% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. For more information, please refer to HYCM’s Risk Disclosure.

Giles Coghlan is Chief Currency Analyst, HYCM – an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders. HYCM is regulated by the internationally recognized financial regulator FCA. HYCM is backed by the HYCM Capital Markets Group established in 1977 with investments in property, financial services, charity, and education. The Group via its relevant subsidiaries have representations in Hong Kong, United Kingdom, Dubai, and Cyprus.

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