03 Mar

Time to look at your investment portfolio

Like most people here in Australia, we’ve been horrified to see the recent developments between Russia and the Ukraine, with the invasion arguably representing the most serious armed conflict in Europe since the end of the second world war.

We’d also add that it makes us cognisant of our relative good fortune to live in a country like this, which despite its flaws, continues to offer a way of life and standard of living that is the envy of people the world over.

Back to the conflict, and while the reaction from world leaders has been almost unanimous in terms of condemnation for the Russian invasion (with some notable exceptions), the desire to impose harsh sanctions has no doubt been somewhat tempered given the reality that some 40% of Europe’s natural gas comes from Russia.

For countries like Germany, which remains the industrial powerhouse of Europe and a key driver of overall European economic output, the dependency is even more profound, with estimates suggesting that more than 50% of Germany’s gas and coal come from Russia.

At the risk of stating the obvious, it’s a very delicate situation, and one that only exacerbates the risk of another market crash and/or global recession.

While it seems borderline inappropriate to discuss financial markets and investments in the current climate, we all still have a certain pool of wealth we need to protect, irrespective of what is happening in the world.

Indeed, a good case can be made that the scenario the world faces right now only makes it more important to look at one’s portfolio, and potentially reassess how the money is invested.

In this week’s market update, we look at one of the largest moves in currency markets on record that has been driven by the crisis, the challenge it poses for Australia, and why recent events only bolster the investment case for pink diamonds.

A currency move for the ages

While most share markets have seen pullbacks in the last few trading days, we are yet to see anything resembling a genuine market crash, like the one we saw when COVID hit, or back during the Global Financial Crisis.

Indeed, you could argue we’ve barely hit correction let alone crash territory, with the US equity market down about 9% for the year, while the local ASX 200 has fallen by about 7%

The scarier price action has been seen in currency markets, with by far the largest move taking place between the Russian Ruble and the US Dollar (see chart below).

Russian Ruble to US Dollar Exchange Rate

Chart of Russian Ruble to US Dollar Exchange Rate

Source: Compound, CharlieBilello.

The Russian ruble has crashed in the last week, and has now fallen an incredible 73% since 2008, around the time the Global Financial Crisis hit.

And while these kind of currency crashes are not something we would ever expect to see in a place like Australia, they do highlight the risk you take when you try and chase some alternative assets.

In recent years, investors have turned to emerging markets including Russia, in the hope of enhancing their returns. It can work, but it’s clearly not without risk, as the last week or so has illustrated.

Moving on to more direct impacts felt locally, and while Australia doesn’t have much in the way of direct trade links with Russia or the Ukraine, it would be naïve to think we will be completely unaffected by the tragedy unfolding there.

Consumer confidence, which is a key driver of economic activity, has already been negatively hit (see chart below), though part of this is no doubt also due to the floods being seen in parts of Eastern Australia, most notably Queensland.

Confidence down 2.6%

Chart of consumer confidence

Source: ANZ-Roy Morgan, ANZ Research

Even before the recent events, confidence was heading in the wrong direction, with ANZ data suggesting confidence levels are 12% below their long-term average.

There is a chance this problem gets worse, not better going forward, as inflation expectations in Australia (i.e. how much Australians think prices will rise in the next year) are now up 5.3%.

Higher petrol prices are a key driver of this inflationary problem, with news reports suggesting prices may rise toward $2.10 per litre (they are likely already there in some parts of the country) in the foreseeable future.

Hard asset demand will be bolstered

While we all hope hostilities in the Ukraine are brought to an immediate end, there is no doubt the events of the last week will have repercussions that will be felt in the global economy, and global financial markets for years to come.

Supply chains, which were already fragile given the impacts of COVID-19, will only be further stretched, while commodity prices, which have been soaring for most of the last two years, have kicked another leg higher.

This has been led by oil, which is up by almost 30% to USD $100 a barrel in just two months, though it’s not just energy prices, with a basket of commodities up by 16% in 2022 so far).

These factors mean that inflation, which is already at multi-decade highs of 7.5% per annum in the United States, is only going to become more of a challenge going forward.

This will act to limit the spending capacity of households, negatively impacting economic growth going forward, and in so doing, may prevent central banks from going through with as many interest rate hikes as they would otherwise have liked to undertake.

Over the long-run, this only makes the outlook for traditional assets like shares, bonds and cash (which was already troubled before this geopolitical flare up), more uncertain.

Given investors will do their best to avoid the risks in the above assets, the demand outlook for genuinely scarce assets like pink diamonds can only be enhanced in such a scenario.

As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and we look forward to any questions or comments you may have.


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