Daily Analysis 4 March 2022 (10-Minute Read)

Hello there,

A fantastic Friday to you as stocks lose their footing on the threat of a nuclear holocaust in Europe is raised by stray shells landing on the continent's largest nuclear power station.

In brief (TL:DR)

  • U.S. stocks were lower Thursday with the Dow Jones Industrial Average (-0.29%), S&P 500 (-0.53%) and the Nasdaq Composite (-1.56%) all down on fears of a nuclear meltdown as an administrative building in Europe's largest nuclear power plant catches fire from shells.

  • Asian stocks sank Friday on reports that a major nuclear power plant is on fire in Ukraine after shelling by Russian troops.

  • Benchmark U.S. 10-year Treasury yields fell nine basis points to 1.75% (yields fall when bond prices rise) on continued concerns over escalation of violence in Ukraine.

  • The dollar ticked higher on demand for haven assets.

  • Oil surged with April 2022 contracts for WTI Crude Oil (Nymex) (+2.47%) at US$110.33 and calls by lawmakers for the U.S. to halt imports of Russian oil feeding into fears of an energy crisis.

  • Gold held gains with April 2022 contracts for Gold (Comex) (+0.04%) at US$1,936.70.

  • Bitcoin (-5.30%) fell to US$41,474 as risk assets in general were rattled on the prospect of the Russian invasion of Ukraine turning nuclear on an accelerated schedule.


In today's issue...

  1. Russia is Setting Up Chernobyl Part Deux

  2. All That Glitters is Not Gold

  3. Cryptocurrencies Could Get Their Derivative Moment


Market Overview

Sentiment was already shaky after Russia’s invasion of its neighbor and transformation into a pariah in the global economy. Energy, metal and grain costs have soared as Russia’s oil and other resources are shunned.

Russia’s military action and sanctions imposed by the U.S. and its allies are creating a range of risks, including high raw material costs, damage to global confidence that can sap investment and the potential for credit stress to ripple through markets.

Traders are also evaluating the monetary policy outlook. U.S. Federal Reserve Chairman Jerome Powell reaffirmed that the central bank is set to start a series of interest-rate hikes to curb inflation, while indicating it will move judiciously.

In the latest U.S. data, the services sector moderated and jobless claims fell by more than forecast, while traders await a key monthly employment report.

Asian markets sank Friday amid fire at a Ukrainian nuclear plant with Tokyo's Nikkei 225 (-2.15%), Hong Kong's Hang Seng Index (-2.10%), Seoul's Kospi Index (-1.16%) and Sydney’s ASX 200 (-0.93%) were all down in the morning trading session.



1. Russia is Setting Up Chernobyl Part Deux

  • While Asia was asleep, Russian forces invading Ukraine have ascended to peak insanity, shelling Europe’s largest nuclear power station, and upping the ante in a war that is rapidly descending into madness.

  • The knee-jerk selloff in equity markets moderated when investors were able to assess the severity of the damage to the nuclear facility, paring earlier losses.

Looking at your investment portfolio today and you may be wondering what happened over the last 24 hours.

While Asia was asleep, Russian forces invading Ukraine have ascended to peak insanity, shelling Europe’s largest nuclear power station, and upping the ante in a war that is rapidly descending into madness.

Blowing up a nuclear power station with artillery shells produces no winners, only dead people and markets quickly priced that in as stock and equity futures sank on the news and Asian markets were roiled at another repeat of the Chernobyl nuclear disaster wrought by Soviet hands.

Observers may be surprised that despite the ferocity of Russia’s attacks on Ukraine, the lights appear to be still on, and public utilities remain available.

The key reason for that of course is some of Ukraine’s many nuclear power stations remain online.

While Kyiv claims that the fire at the Zaporizhzhia nuclear power station hasn’t yet affected “essential” equipment, shells raining down from Russian artillery are getting a little too close for comfort in a rapidly escalating war.

The knee-jerk selloff in equity markets moderated when investors were able to assess the severity of the damage to the nuclear facility, paring earlier losses.

Fortunately, regulators confirm that radiation levels around the nuclear power plant in the eastern region of Ukraine remain normal, as shells hit an administrative building and not the reactor.

As the Russian invasion of Ukraine enters its second deadly week, investors are understandably growing concerned that an increasingly frustrated Russian President Vladimir Putin will resort to more desperate means to achieve his goals, including the targeting of critical infrastructure.

Two days ago, a missile attack targeting Kyiv’s TV tower was a clear sign that Moscow intends to decapitate Ukrainian President Volodymyr Zelenskiy’s ability to communicate and cutting off electricity would be key to achieving that plan.

Moscow’s strategy to cut essential services such as water and electricity from Ukraine’s cities could be part of a plan to decapitate its command structures and perhaps attempt to force an end to the conflict which has been bogged down in the north.



2. All That Glitters is Not Gold

  • According to a study by Citigroup, spikes in the price of gold because of military action or terrorist strikes have tended to be temporary and that may be playing out in real time.

  • The reason for that of course is gold doesn’t generate any yield and has limited applications outside of jewelry and as an alleged hedge against inflation, and even that role appears to only be effective across very long periods.

All that glitters is not gold, at least not historically.

While the price of gold may have been soaring since the onset of the Russian invasion of Ukraine, if history is anything to go by, that rally may prove to be shortlived.

According to a study by Citigroup (-3.26%), spikes in the price of gold because of military action or terrorist strikes have tended to be temporary and that may be playing out in real time.

Despite jumping 3.4% on February 24, when Russia launched a full-scale invasion of Ukraine, prices for gold have since consolidated, even as other commodities such as oil, wheat and aluminum have accelerated.

The reason for that of course is gold doesn’t generate any yield and has limited applications outside of jewelry and as an alleged hedge against inflation, and even that role appears to only be effective across very long periods.

Instead, other commodities essential to life like energy and food will see serious supply-side shocks for as long as the Russian invasion continues.

In the medium term, rising interest rates could also present a real headwind to the non-interest-bearing metal, whereas demand for industrial metals is likely to persist thanks to supply chain disruptions caused by the pandemic and exacerbated by the Ukraine crisis.

Last year, Goldman Sachs (-0.88%) and Citigroup forecast that gold would hit as high as US$2,300 on the back of rising inflation, but have since pared back those projections, to a 30% bull case for gold to hit a fresh record US$2,100 this year.

Gold is particularly risky as a hedge because the end of hostilities in Ukraine could suddenly see a sharp reversal, with bullion possibly falling to as low as US$1,800 or lower.

Investors could perhaps take a lesson from history – during the Battle of Waterloo, the Rothschilds bet that the war with France and Great Britain would map out a similar path to previous conflicts and be a long-drawn-out affair and bet heavily on gold accordingly.

Gold was essential for raising armies in the early 19th century and the Rothschilds took the view that demand would be persistent so gathered as much as they could.

However, when the armies of Napoleon were defeated quickly at Waterloo, demand for gold also vanished just as rapidly.

Fast forward to the present and introducing gold into a portfolio at this stage could subject investors to far more volatility, rather than serve the role as a hedge against geopolitical uncertainty.

Medium term, as interest rates rise, the investment case for gold could decline and undermine the very raison d'être for taking a long position on gold to begin with.



3. Cryptocurrencies Could Get Their Derivative Moment

  • The Biden administration has openly declared its intent to be front and center of cryptocurrency regulation and that was echoed by Biden’s four nominees to join the CFTC.

  • So far, Wall Street’s foray into cryptocurrencies have tended to nibble on the fringe, because of the lack of clear regulation or a comprehensive framework governing the nascent digital asset industry.

From asset non grata just several years ago to top of the agenda for U.S. President Joe Biden’s nominees to the U.S. Commodity Futures Trading Commission (CFTC), cryptocurrencies have come a long way.

The Biden administration has openly declared its intent to be front and center of cryptocurrency regulation and that was echoed by Biden’s four nominees to join the CFTC.

At a confirmation hearing before the Senate Agriculture Committee, Biden’s CFTC nominees said the agency’s history of overseeing cryptocurrency derivatives put it in an ideal position to do more to regulate the cryptocurrency industry as a whole.

To be sure, the CFTC allowed for the creation of CME and Cboe’s first forays into cryptocurrencies through their Bitcoin and then Ether, cash-settled futures and paved the way for the first Bitcoin ETF in the U.S., albeit one underpinned by those very futures.

Last month, CFTC Chairman Rostin Behnam told lawmakers that they should consider giving the regulator more authority to oversee cryptocurrencies and expand the budget for the agency by at least US$100 million.

Because cryptocurrencies straddle various specific types of securities, a turf war for jurisdiction has been waged between agencies over the past several years over which one should have the right to regulate cryptocurrencies.

For now, the CFTC’s role has been limited to oversight of derivatives based on Bitcoin and Ether, as well as investigating allegations of fraud or manipulation in underlying markets, but is chomping at the bit to do more.

Meanwhile, the U.S. Securities and Exchange Commission, helmed by the crypto-savvy Gary Gensler, has been making waves for suggesting that most cryptocurrencies fall under his agency’s tough investor protection rules, akin to securities, which most industry stakeholders have rejected.

Making matters more complex for regulators, Biden CFTC nominee Christy Romero said the agency still lacked visibility of the underlying cryptocurrency markets, but expanding the role of the CFTC to cryptocurrency derivatives could be the first step in greater institutional adoption.

So far, Wall Street’s foray into cryptocurrencies have tended to nibble on the fringe, because of the lack of clear regulation or a comprehensive framework governing the nascent digital asset industry.

Certainty provided by the CFTC could rapidly change that situation as financial institutions would enjoy the regulatory certainty that could provide and potentially provide greater access to more clients and investors.

That move towards regulation and standardization may be closer than anticipated, with the International Swaps and Derivatives Association already putting out whitepapers on suggested formats and terms for digital asset contracts.

All of which have the potential to supercharge cryptocurrency derivative products and push them into the more mainstream world of finance.

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