Tim Toohey: How Ukraine war will affect stocks, bonds and commodities

Russian boots are now on the ground in Ukraine. The invasion is underway. Our initial thought, of course, must be the terrible human tragedy that will unfold over the coming weeks, months and (hopefully not, but possibly) years. But as a financial news and analysis website, we’re considering the financial implications. And there are plenty of them.

At a market level, the NASDAQ yesterday fell as much as 21% from its November highs, before “dip buyers” swept in and saw the index close 3.4% above its starting point.

In Australia, the ASX 200 lost 3% in yesterday’s morning session before recovering slightly, now sitting about 2.5% below its Thursday open.

Brent crude prices have fared better, up almost 3.5% a barrel on Thursday, its best day in just under 12 months.

The escalation of the Russia-Ukraine conflict was a key topic of discussion in Patrick Poke's recent podcast interview with Tim Toohey, Yarra Capital Management's head of macro and strategy. Toohey is also a former chief economist, having worked for Goldman Sachs and Ellerston Capital.

Macro

What war in Ukraine means for investors

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He points to the rapid about-face in equities and also notes that bonds have remained largely flat since the first Russian missiles landed in Kyiv.

“It’s always going to be in investors' minds as to how much you should react ahead of a particular event. Many portfolio managers probably haven't moved their portfolios much at all,” Toohey says.

“No one knows what Putin's full intentions are, whether it's a full-on invasion, a partial land grab or whether he’s trying to secure some sort of agreement that Ukraine is not admitted into NATO. But under the latter scenario, you could see de-escalation happen quite quickly and we could see markets bounce reasonably quickly.”

On the other hand, if Putin’s intent is to absorb Ukraine into Russia – which at this stage appears the more likely scenario – the conflict’s duration could be far longer.

The underlying reason for Russia’s invasion is to prevent Ukraine’s admission to the North Atlantic Treaty Organization.

“If you put your feet in Putin's very expensive shoes for a moment and look at a map, it’s interesting that over the last 20 odd years, there's been a big advancement of NATO, right onto the Russian border,” Toohey says.

“Areas such as Lithuania, Estonia and others next to Russia have certainly joined NATO. And then down south, adjoining Ukraine, you have had a whole host of nations including Bulgaria and Slovakia and others that have really taken land. Should Ukraine join as well?”

Ukraine is the second-biggest country in Europe, its landmass surrounding most of the Black Sea, which is strategically important to Russia. And the border that adjoins the two nations is heavily populated, particularly on the Russian side.

"A prize Russia can't ignore"

Toohey describes Ukraine as “a prize that Russia just can’t afford to lose.”

But from a broader economic perspective, Ukraine is tiny, with a GDP of around US$185 billion – less than 0.1% of the global total. And Russia’s not much bigger, with a GDP that’s only slightly higher than Ukraine’s.

“For the West to launch a full-on military engagement against Russia in Ukraine is just not something they’re willing to contemplate. But if we do get into that scenario, then this current risk-off event is going to keep going,” Toohey says.

What does it mean for Australia?

It’s unlikely any local troops will be committed to the conflict. The effect on commodities, on which around two-thirds of our GDP relies, is the primary consideration for Australia.

Toohey looks back at what happened to wool prices during the Korean War, when the US stockpiled the material.

“Our wool price went to the moon. But the starting point is already a world where most raw materials, most commodities, are already at pretty low inventory levels,” he says.

If a similar scenario plays out this time, where international governments try to build stockpiles for what could become a full-blown war, Toohey suggests it could further exacerbate the supply chain blockages with which the world economy is already grappling.

Indeed, at least one commentator has suggested an economic attack on the Western world’s asset prices is one of Putin’s core motivations.

Adam Butler, from US asset manager and research firm ReSolve, says Putin has “expertly timed his actions to target what the west values most: financial assets."

“Governments and central banks have no good options. Asset prices may either suffer materially in the short term or suffer even greater horrors in the long term. There are no good options.”

Comparing the current situation with previous conflicts, the effect on credit markets has been far less pronounced.

During World War 1 and World War 2, bond issuance by governments surged as a way of financing national manufacturing and other military programs.

“In this environment, bonds should be rallying, but we haven’t seen that so far. Maybe the focus is still on the inflation threat and the Fed moves but typically, even other minor have seen pretty decent bond rallies,” Toohey says.

“Coming out of the pandemic, fiscal finances are already stretched. If we go into genuine conflict, governments will need to lift their issuances to finance their efforts. It’s curious that the bond market has been so resilient.”

What the war means for commodities

Gold is an obvious safe-haven asset and has already seen an influx of allocations. Energy is another key consideration, especially given around 50% of Russia’s economy hinges on oil and gas, which it supplies primarily to other European nations.

And what’s Toohey’s preferred way of getting gold exposure? Exchange-traded funds.

For an active portfolio, he believes an allocation of between 5% and 7% is “about right.” Toohey cautions against holding physical gold.

“I would favour ETFs that map the gold bullion price. Not those that are a combination of gold, gold companies and even derivatives. You probably want to avoid those,” he says.

Pure gold exposure ETFs are regarded as more liquid and align more closely with the gold price than other vehicles.

Toohey also points to industrial metals, whose inventories are also quite stretched already.

“You’d still probably put a bid under iron ore,” he says.

“Most modern warfare's done with chips and computers, so you also have to recalibrate your thinking towards some of those commodities.”

Copper is another key commodity in this regard, which also has tight demand dynamics now.

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