Feb 10/15 – The Ukraine conflict is about to get called up to the major leagues…

2015-02-10 9am EDT  |  #gold #Merkel #Obama #Putin #Russia #Ukraine

I try to avoid discussing politics in this letter. At the end of the day, the last thing we need is another knob on the internet spouting his wisdom on how to fix all the world’s ills. Instead I try to focus on how these political realities will affect the market. Although my personal views might shine through in the language I use to describe the situation, I really have no interest in trying to convince you about what should be done, but instead want to remind you as traders, all that matters is what will be done.

Over the past few weeks I have watched as my favourite warmonger has advocated for the United States to arm the Ukrainian people to fight the Russian invaders. Of course he wants to arm the Ukrainians. Senator John McCain has never seen a conflict he doesn’t think wouldn’t be fixed by the Americans selling weapons to one side. (In fact, I am even pretty sure that it was McCain that helped finance the rebels defeat of Darth Vader’s Imperial Forces.)

It should be no surprise then that McCain has been pushing hard for the US to arm the Ukrainian government.

Republicans and Democrats on the Senate Armed Services Committee made a big push on the issue, while a bipartisan group of House members called for the same course of action in a letter.
“The United States must act with urgency to provide defensive lethal assistance to Ukraine,” said Sen. John McCain (R-Ariz.), the chairman of the Armed Services Committee.
“We are calling on the Administration to increase its support for Ukraine. Tighter sanctions and greater humanitarian assistance should be part of that support, but now, more than ever, the U.S. must supply Ukraine with the means to defend itself,” they said in their letter.
“Blankets don’t do very well against tanks,” said McCain. Providing arms “will raise the risk and costs Russia must incur to continue its offensive,” he said.

So far the Administration has resisted the looming call of the banging on the war drums, but it is getting more difficult. The economic sanctions are hurting Russia, yet Putin is showing no signs of easing up on his aggression in Ukraine. As Russia continues its offensive, the pressure is ratcheting up on Obama to do something. He will only be able to hold off the hawks in his government for so long.

Yesterday Obama met with Germany’s Angela Merkel to discuss the situation.

Although in the subsequent press conference Merkel was much more dovish than Obama, the fact that she came to America indicates that this situation has taken a turn for the worse.

“I can only say that if we give up on this principle of territorial integrity of countries, then we will not be able to maintain the peaceful order of Europe that we’ve been able to achieve,” she said.
Merkel, however, has said introducing more weaponry into the fight only stands to escalate an already difficult situation.
“The progress that Ukraine needs cannot be achieved with more weapons,” she said last week. “I have grave doubts about the validity of this point.”
Merkel said she believes that if the West sends weapons to Ukraine, Russia could further step up its involvement in the conflict, possibly introducing its air force into the fight.

My guess is that Merkel visited Obama to have a final meeting before the conflict gets escalated to the next level (which should make McCain especially happy).

The real question that needs to be asked is what is going on in Putin’s head? Many Western analysts are confused why he keeps pushing so hard. He seems to have everything to lose with so little to gain.

I have long been skeptical about the notion that Russia will back down. Putin’s aggression is much more calculated than the West gives him credit for. Although American analysts talk about how Russia is now bankrupt and susceptible to collapsing, I believe that Putin is convinced that it is America who is weak and unable to protect other countries.

Russian President Vladimir Putin struck a defiant tone a day after talks in Moscow with the leaders of Germany and France failed to achieve a breakthrough in resolving the Ukraine crisis.
Russia won't tolerate the post-Cold War global system dominated by a single leader, Putin said Saturday at a meeting with the Federation of Independent Trade Unions in Sochi.
"That type of world order has never been acceptable for Russia," Putin said. "Maybe someone likes it and wants to live under a pseudo-occupation, but we won't put up with it."

Putin will keep pushing until he is stopped. Obama hoped that economic sanctions would be enough to stop him, but it is now obvious that sanctions will not be enough.

Regardless of whether you or I think America should become involved in the conflict is irrelevant. I actually don’t know what I would do if I were Obama, but that doesn’t matter. The only important part of this analysis is to realize what will be done.

The conflict will take a turn for the worse in the coming weeks. McCain will get his way and the Ukrainians will get their requested weapons. Economic sanctions might even be notched up to the next level at the same time.

The market is no where near ready to accept this reality. When this conflict first started every Russian tank movement caused the S&P 500 to give up 25 handles in a blink of an eye. However since World War III didn’t break out immediately, the market believes that the conflict does not matter. As usual the market is not nearly as efficient as Burton Malkiel, our favourite ivory tower Princeton economist, would have us believe. The market previously over reacted to each troop movement, and when that didn’t prove immediately fruitful for the hair trigger traders, the conflict was increasingly ignored.

The market is under estimating the possibility of this conflict taking a dramatic turn for the worse. I expect that as the seriousness of this next move filters down through governments contacts to the hedge funds, the market will care again.

Don’t be fooled into thinking that this situation is not serious because the market is not yet reacting. There is probably more risk from the Ukraine at this moment than any time since this conflict began. Trade accordingly.

Gold is a better alternative currency than the bears believe…

Yesterday I was chatting with a colleague about the performance of gold over the past few months. Although gold has bounced nicely off the year end lows, the move from $1,150 to $1,240 is no barn burner performance by any means. Yet as a Canadian, when I look at gold’s return during this period, I am reminded of its true power as a currency alternative. My gold priced in Canadian dollars has actually rallied from $1,300 CAD per gold oz. to $1,550 CAD. The return has been almost double in Canadian dollars.

And the returns in local terms have been even higher for the Europeans. Or how about the Russians? Or the Ukrainians? Or the Belarusians? (writing that out reminds me so much of a Star Trek episode I think they should use it in a marketing campaign.)

All of these nations have seen the price of gold in local currency terms head dramatically higher over the past few months. The traditional role of gold as a store of value has been much more effective than the gold bears would have you believe…

I am long some gold equities, but I am becoming even more excited about non-US companies. The input costs for a Canadian or Australian gold mine are not rising, yet the revenues from their output have been trending higher as the US dollar has rallied. The rise of gold priced in local currency terms is exactly what these companies need…