Over the past few days, we have learned that American and EU sanctions against Russia are escalating, and they are having palpable consequences on Russia’s economy. S&P and Fitch are thinking about downgrading Russia’s credit rating as they are concerned that these sanctions will hit Russia’s economy. Furthermore, the Russian Ruble and the Russian stock market — the MICEX — are falling in value.
But while the impact on Russia is fairly straightforward, there isn’t enough emphasis on the consequences of these sanctions on Western economies. I think these consequences will be very real, and we are already seeing signs of this.
The threat to the U. S. that has been brought up is the fact that Russia holds $132 billion in Treasuries. The fear is that in the wake of an economic war Russia could end up selling its Treasuries and that this would put pressure on interest rates in the United States. This could readily happen, but $132 billion in Treasuries just isn’t that much to make a difference. The world’s largest holders of Treasury securities hold ten-times this amount, and the U.S. government issues this amount of Treasuries many times over in the course of a year. While a sale by Russia may generate a short term spike in rates, the excess supply will be quickly bought up by other parties. If there is any risk here it is that a Treasury liquidation by Russia might spawn the same in a potential political ally with a larger holding such as China, but a Russian sale in itself is not that significant in the broader scheme of things.
There are a couple of other threats that have not been addressed adequately but which need to be. The most intuitive is that Western companies that do business in Russia can suffer. For instance, we saw recently that due to American sanctions that Visa (NYSE:V) and Mastercard (NYSE:MA) cannot do business in Russia for the time being. While this doesn’t materially impact Visa, it does impact Mastercard, which has a substantial business in Europe. It is for this reason that I suspect that Mastercard shares were down 3 percent on Friday on heavy volume (14.4 million shares versus a trailing 30 day average of about 5.6 million shares.) Another potential loser could be PepsiCo (NYSE:PEP), which purchased the Russian dairy company Wimm-Bill-Dann back in 2011, although this stock has not reacted to the problems in Russia.
Most importantly, however, is Russia’s role in the global commodity market. Given its large geographical size Russia is among the top producers of several of the world’s most important commodities. Here is a short list:
- Russia is the world’s top oil producing nation.
- Russia is the world’s top palladium producing nation.
- Russia is second only to China in nickel production.
- Russia is fifth in wheat production.
These are all vital commodities to the global economy, and a sanction against Russia is going to impact the prices of these commodities. While oil prices haven’t really reacted yet, palladium and nickel prices have. Palladium is up 11 percent and nickel is up 20 percent year-to-date. Given that Russia’s role in the palladium market is especially dominant (it controls more than 40 percent of the market), a reaction to Western sanctions by Russia could seriously hurt those Western countries that use palladium such as automobile manufacturers who use palladium and the much more highly priced platinum in order to manufacture catalytic converters.
Given these threats, investors are encouraged to take the following advice. First, research your equity holdings and determine how much exposure to Russia they have. If you are uncomfortable investing in Russia, sell them before the market figures out that these companies (e.g. PepsiCo) have exposure to Russia. If you are comfortable investing in Russia as a contrarian play, then consider buying shares in these companies after the market has discounted their Russian exposure (e.g. Mastercard.)
Second, be careful when you invest in companies that will suffer if commodity prices rise. A lot of companies use a lot of oil, and as I have already mentioned, automobile manufacturers might suffer if palladium prices rise. Also, consider investing in companies that will benefit from prices of these commodities rising. These don’t just have to be oil, nickel, and palladium producers. For instance, railroad companies might benefit because they use less oil than trucks, and a rise in oil prices will shift business away from trucking companies and towards railroad companies.
Investors who follow this advice should avoid the pitfalls that will result from an economic war between Russia and the West, and they may be able to profit substantially.
Disclosure: Ben Kramer-Miller is long Visa. He is also long Russian stocks through the Market Vectors Russia ETF and the Market Vectors Russia Small Cap ETF. Ben is long railroad company CSX Corp and also owns palladium coins.