Gold’s rally through February, its recent peak on 08 March, and subsequent pullback suggests that prices aren’t necessarily baking in any eventuality but responding acutely to the latest developments on the Russia-Ukraine front. Investors typically turn towards gold when geopolitics, or any other major disruption, creates risks to global economic growth. The ongoing conflict has threatened to leave a lasting fracture in supply chains which, in turn, will have a knock-on effect on growth. We think this has put central banks in a pickle. The Federal Reserve, and others, will not only have to tighten while growth may be slowing down, but tighten policy amid heightened geopolitical risks. The combination of geopolitics and reduced freedom for central banks to withdraw policy accommodation despite rising inflation is, in theory, a highly conducive environment for gold. We don’t think current prices reflect such a scenario.

Gold has historically been seen as an effective geopolitical hedge but especially so when investors perceive the geopolitics to pose a threat to economic growth. With the ongoing conflict adding to inflationary pressures through broken supply chains and rising commodity prices, investors are increasingly adding gold to hedge against the risk. If the conflict does not come to a resolution soon, major central banks including the US Federal Reserve may also be forced to rethink their policy tightening schedule this year. Higher inflation for longer alongside a dovish tilt from central banks could help keep gold supported.

The US has banned the import of oil and other energy products from Russia while the UK has said that it will phase out Russian imports by the end of the year. While no sanctions have been imposed on Russian energy exports, the move is designed to put additional pressure on Russia. Oil prices remain volatile as market participants continue to react to the latest developments. Europe has not yet followed suit. Around 41% of European Union’s gas imports, and 27% of oil imports come from Russia (according to the European Commission).

Energy stocks are the only industry group in the S&P 500 Index that have delivered positive gains year to date (as of 02 March 2022). All other sectors are down with growth-oriented stocks experiencing the severest pullback. This is also illustrated by the larger drawdown in the tech-heavy NASDAQ 100 Index over the same period. The fortunes of energy stocks are naturally aligned with oil prices which, in turn, are tied to the Ukraine conflict in the near term. Volatility in stock markets remains elevated with the CBOE Volatility Index (VIX) reaching its highest level in over a year at the start of March.

Oil prices are continuing to soar in response to the ongoing war in Ukraine as markets are beginning to price in the impact of Russian oil supply going offline. The International Energy Agency (IEA) has warned that the situation in the energy markets is very serious, and that global energy security is under threat. According to Interfax, Russia exported 4.6 million barrels per day in January and February. To replace such a volume, the Organization of the Petroleum Exporting Countries (OPEC) will need to tap into the entirety of its spare capacity. 

Geopolitics have had an impact on several commodities in recent weeks. Gold, unlike other commodities like oil, natural gas, nickel, and wheat that are face a risk of supply shortages, has been buoyed by its defensive characteristics. Gold has historically been used by investors as a hedge against elevated macro risks such as geopolitical tensions or economic uncertainty. With ongoing tensions between Russia and Ukraine, gold has breached the $1900/oz for the first time since the middle of last year. 

Geopolitical tensions between Russia and Ukraine have also impacted industrial metals. Among the commodities affected are nickel and aluminium for which Russia is a key supplier. If tensions subside, inevitably some of the shine could come off these metals. But the backwardation in both, an otherwise unusual state for industrial metals, extends much further into the future. A combination of underinvestment in the global mining sector and growing demand for base metals is creating the risk of metals being undersupplied in the years to come pushing several industrial metals curves into backwardation. Tin too, for the same reason, was among the top performing commodities last year and is continuing to make gains at the start of 2022.

Commodities that had been pricing in a geopolitical risk premium in recent weeks pulled back slightly on 15 February as news emerged that Russia may be withdrawing some troops from the Ukraine border. Several commodities including oil, natural gas, palladium, and wheat, among other, have priced in the risk of supply shortages in the event of a major conflict. If tensions subside further, price may cool down bringing the focus in these markets back to fundamentals. 

According to FactSet (as of 14 February), 75% of S&P 500 companies cited ‘inflation’ in their fourth quarter earnings calls. Nevertheless, earnings growth remains on track. FactSet also reported, on 11 February, 30% earnings growth for S&P 500 companies for a fourth straight quarter and earnings growth of more than 45% for the full year. These above-average growth rates are due to a combination of higher earnings in 2021 and an easier comparison to weaker earnings in 2020 due to the negative impact of COVID-19 on a number of industries.

Growth stocks pulled back sharply in January as markets priced in multiple interest rate increases from the US Federal Reserve this year. Value, in contrast, has been relatively shielded with lower duration stocks, i.e., stocks with more weighty cash flows now (as opposed to later), being in demand. Investors are particularly looking at dividend paying companies. The urge to rotate towards bonds in periods of rising rates is reduced when investors can get a yield from their equity exposures.