For those of you who would prefer to listen:
It’s been 17 months since Russia invaded Ukraine. It was widely believed initially that Kyiv would fall in a matter of days. It didn’t. The resolve of the Ukrainian people was completely underestimated.
The War in Ukraine has not had much of an impact on the Market. Of course, the price of Oil spiked at the outset of the invasion. But it has since given up all of those gains.
Neither Russia nor Ukraine are major economic powers. But they are very instrumental in the global food supply. The region is often referred to as the “Bread Basket.” Ukraine and Russia, account for a third of the World’s wheat exports, a fifth of its corn trade and nearly 80% of sunflower oil production. These countries export a high percentage of fertilizer too. Commodities are big business there.
Russia has long been one of the largest Oil & Gas producers in the World. Because of the sanctions, they’re exporting a lot less than they used to. And at much lower prices. Russian Oil has been selling below $60 per barrel, a steep discount to WTI and Brent.
Russia is decisively still a 20th-century economy. It is heavily dependent on fossil fuels. Russia feels left out of globalization. The Eastern Bloc of the former Soviet Union largely integrated into NATO and the European Union. Not Russia. Putin blames the US for this. Ukraine was stuck in the middle. All Ukraine did was want a democratically led nation. Putin clearly doesn’t want that. Putin’s regime has long been threatened by a freer-thinking Ukraine aligned with the West. His fears have been played out; much of it his own doing.
What about China? The new Chinese-Russian strategic relationship has these nations closer than any other period in five decades. But China finds itself in a difficult spot now. How much did China know about Russian plans? That remains unclear. It is unlikely that China was totally surprised by the invasion. It is, however, likely that China was surprised by the aggressive, coordinated response by the West. I think it’s safe to say most of the World was surprised that the NATO alliance strengthened to levels that rival the early days since its inception, following the Second World War.
I recently participated in a session with a Retired CIA Operative named David Bridges. He was a wealth of insight and knowledge on the subject of Russia and geopolitics in general. It’s so helpful to have such strategic resources to try to help make sense of so many dangerous and confusing developments across the globe. Bridges started off trying to answer the question of what just happened with the failed mutiny/coup in Russia.
Some Background: Yevgeny Prigozhin is the leader of a Russian mercenary army called Wagner. Prigozhin spent much of the 1980s in jail. Bridges called him a criminal. Most do. Both Putin and Prigozhin have known each other for decades. They grew up in Leningrad, which of course, today is St. Petersburg, its original name prior to the Bolshevik Revolution. Importantly, Prigozhin knew Putin before Putin was anything.
Prigozhin is often referred to as “Putin’s Caterer.” He became a wealthy Oligarch, strategically positioning himself within the inner circle of the Kremlin. He started off selling hot dogs on the street. Who knew that was a pathway to extreme power in Moscow and beyond. The Prigozhin-led Wagner group has been active in Syria, Africa, and, of course, now Ukraine, on behalf of Russian intelligence.
Prigozhin has earned a reputation as the cruelest commander among those leading Russia’s military operations. Those in the inner circle say, he is driven by the thrill of the chase, more than the money. It’s been said that Prigozhin believes he is battling corrupt elites on behalf of the Russian people. There is clearly a desire to crush his rivals. That’s why the coup and then its sudden stoppage was so strange.
David Bridges referred to the Russian government as one big Mafia confederation. They all feud against each other. Putin oversees them all, strategically playing one another against each other. That’s a dangerous game. It requires absolute power. It certainly backfired when Prigozhin went rogue.
Yevgeny Prigozhin’s whereabouts had been unknown until this week. It wasn’t clear whether he was in Belarus or back in Russia. Prigozhin made his first public appearance since the attempted mutiny. Putin publicly called it an act of treason. Prigozhin said that the mercenaries will not be participating in the invasion of Ukraine, saying, “What is going on the front line today is a shame in which we shouldn’t take part. We may return to the special military operation when we feel sure that we will not be forced to put shame on ourselves.” This Russian paramilitary group will allegedly be moving back to combat in Africa. At least for now.
This is not a good look for Russia. Putin is trying to save face and maintain the Wagner organization. Wagner has been essential to Russia’s military operation. The Russian Defense Department is very uneasy. Putin’s biggest risk is his own advisers. There is a new precedent for pushback. That’s very new in the Putin regime. It’s never happened before.
Prigozhin’s uprising was indicative of what’s clearly become deep fractures within the Russian elite. The British Spy Chief described that bizarre event like this: “Prigozhin started off as a traitor at breakfast. He had been pardoned by supper and then a few days later, he was invited for tea.” That sort of sums it up.
Vladimir Putin is aging. At 70 years old, his power sure looks like it’s slipping. His physical health is believed to be fine. Putin exercises regularly. He apparently doesn’t smoke or drink a lot. It’s the Digital Age that is passing him up.
Putin doesn’t use the phone or the internet. He lives in paper. Putin reportedly does not have many trusted sources either. Bad news doesn’t make it to his desk very often. He lives in fear and is apparently pathologically afraid of Covid. Vladimir Putin is completely removed from reality. Then there’s this: Russia has no clear successor. That is a very dangerous situation for this nuclear power and the World.
Everyone has an expiration date. It’s only a matter of time. Vladimir Putin’s path to power rose with his vast KGB contacts. He made them rich. It’s often said that Putin believes the failure of the Soviet Union was the greatest tragedy of the 20th century. Russia is fighting a hard battle of power and relevancy in the 21st century. Those in the know believe that replacing Putin, whenever that is, most likely will be a collective solution. It will no doubt be bumpy.
Russia has relied on Oil for decades. Among the top producers and exporters in the World, Russia counted on Petro Dollars to fund its government. Vladimir Putin made some major miscalculations by invading Ukraine. He grossly underestimated the response from the US and the West. Russian Oil was sanctioned, reducing the volume and price on the global market. Europe still spent $150 Billion on Russian Oil and gas last year. But European countries have made major strides in diversifying their dependence on Russian energy. That trend is likely irreversible, at least for the foreseeable future. Russia relies heavily on Western technology for its antiquated infrastructure. It’s in bad shape.
Russia keeps exporting wheat as well as Oil to help keep its Economy alive and pay for the war. Egypt is the largest buyer of Russian wheat, importing nearly 12 Million tons last year. That accounted for nearly 1/4 of all Russian exports. Turkey was the second biggest buyer, with just over 10 Million tons. In case you’re wondering, Algeria, Iran, and Saudi Arabia round out the top 5.
Russia this week reminded the World just how quickly it can foul up global food supplies and prices. Moscow broke a promise for the wartime deal that allowed grain to flow from Ukraine to countries in Africa, the Middle East and Asia where hunger is a growing threat and high food prices have pushed more people into poverty. It is known as the Black Sea Grain Initiative, which was brokered by the United Nations and Turkey last year. Grain prices fell 20% when the deal was reached. They’re heading back higher now, putting more inflation pressure around the World. There’s also a growing number of hungry people. It’s not good.
China has cultivated a stronger relationship with Russia in recent years. The two nations formed an alliance in 2022 at the Winter Olympic Games in Beijing. Presidents Putin and Xi called each other best friends. Perhaps more accurately, they’re like “Frenemies.” China and Russia share one common characteristic: They have a deep distrust for the United States. The alliance made geopolitical sense. Russia invaded Ukraine shortly thereafter. It’s far from clear whether President Xi knew it was coming.
The state of the Russia-China relationship has naturally frayed. President Xi is trying to be pragmatic and calculated. According to retired CIA Operative Bridges, Xi understood early on that a deal with Russia was risky. Both nations said their alliance was limitless. Xi clearly miscalculated too. There are definite limits to these ties.
China is perfectly happy to buy Russian Oil on sale at discounted prices. The Chinese need cheap and abundant energy, so it has long focused on diversified sources. Russia has become increasingly dependent on China in response to this war. China has the upper hand here and will use it.
China is in much tougher shape than previously thought. The nation is starved for foreign investment and struggling to find it. The perception that doing business in China has become much riskier and is choking the flow of capital into an economy already struggling. China is suffering from low private investment and reduced consumption. The country has soaring youth unemployment, clearing 20% of that population. It is devastating for the Chinese Economy, which has been viewed as the global growth engine for decades.
International investment in China fell to just $20 Billion in the first quarter of this year. It was over $100 billion a year ago. This is a stunning change for a country that over the past four decades has consistently seen more money coming in than going out. For Chinese leaders, keeping pressure on foreign firms while simultaneously trying to get them to invest has become a treacherous balancing act. It threatens to deprive the country of the capital, technology, ideas and management skills that have fueled China’s rise. That effort is on a collision course with President Xi’s national-security agenda, targeting perceived foreign threats. That has made any Chinese investment a potential minefield for foreign firms. Investment capital is looking elsewhere.
Secretary of State Janet Yellen was just in China. Her goal was to maintain diaglogue and try to negotiate some of the many issues plaguing the two economic powers. American company treatment is atop the list. There isn’t a lot of transparency and fairness. Washington plans to propose a final list of investment limits into China by the end of August. Investment curbs will likely be focused on semiconductors, quantum computing and AI. Implementation would start in 2024. Our Washington sources said the six-month delay in imposing these curbs would give the White House time to ease tensions with Beijing, assess public and corporate feedback, while also appeasing Corporate America and China hawks from both sides of the aisle.
There’s a prevailing view throughout the West: Ukraine fights Russia today, or we do it tomorrow. Taken a step further, many feel that the outcome in Ukraine will have great influence on the fate of Taiwan. When asked how the war in Ukraine ends, David Bridges had a long and very thoughtful answer. Ukraine is crystal clear: Russia needs to get out. But Russia is showing no signs of leaving and its power structure is proving to be the most questionable it’s been since the Wall came down. He believes the war continues through 2023 and into 2024.
Bridges laid out 4 possible outcomes he sees, with percentage of likelihood.
- Russian victory – 10%
- Ukraine victory – 20%
- Stalemate – much like Korea – 10%
- Escalation – 60%
What would Escalation look like? Russian cyberattacks and sabotage are very likely. Nuclear weapons are very unlikely. That said, it can never be ruled out. Especially with a wounded power that is desperate.
Something really important that Bridges pointed out, which I certainly wasn’t aware of, is the fact that 75% of Northern Hemisphere data telecom cables travel below the Irish Sea channels. It’s a weak spot. Russia knows it. Microsoft, Google, Amazon and Facebook own or lease over half the capacity. This makes the Western World very vulnerable to cyberattack, knocking out global communications and commerce.
The United States has been sending substantial military supplies and equipment to Ukraine. At first, we were sending things off the shelf. The size and scope and length of the war has been grossly underestimated. Now we are exposing our own weakness, currently undersupplied to defend ourselves.
A significant milestone was reached in June. It’s not good. America now spends more to service our $32 Trillion debt than we allocate for military defense. The United States needs more investment in defense. We aren’t alone. Europe has underinvested for decades while redeploying that money into social spending. Europe is finally spending aggressively on defense. That will continue. This is great for US Defense companies.
There are some political games being played in Washington relating to military funding. It’s all for show, according to our sources. The Defense Department is the largest government agency and strategically has every state in the union producing something for America’s defense effort. When it comes down to it, America’s defense has unconditional support.
China is reportedly now in Cuba. The State Department has raised concerns that the Chinese have established military training facilities 90 miles off the Florida coast. It’s believed they’ve been there since 2019. Beijing is trying to expand its military reach. China still can’t protect their own sea lanes. They’ve been hyperactive in the South China Sea to send messages of intent. China also wants a Middle East base but so far has been unsuccessful in that quest.
I asked Mr. Bridges about the importance of the Quadrilateral Security Dialogue, more commonly known as the Quad. It’s the alliance between India, Australia, Japan and the United States. He said it’s a great idea and has strategic significance and potential, but the alliance is still new and notional. Bridges believes the greatest strength of the Quad is its economic capabilities. These are 3 of the top 5 economies in the World.
Soft power in Asia is on the rise. Japan is increasing defense spending and will be felt. Australia is fairly limited in projecting power. And India still has ties to Russia, though it has made some major progress with the United States and the Western World of late, as Prime Minister Modi made landmark visits.
Back to the Market:
There’s been a great deal of rotation below the surface. The Dow increased 10 straight sessions, the longest winning streak since 2017. The NAS and S&P have stalled, which is new. The Dow has been the laggard all year. It hasn’t paid to be diversified in 2023.
Health Care, Energy, Aerospace & Defense and Utilities have strengthened of late while Tech has started to digest those massive gains. Treasury yields have stopped their declines, as has the Dollar. The Dollar was strong this week. Gold has remained firm while the price of Oil has caught another bid.
Inflation pressures had been receding of late, with the better-than-expected CPI report last week. The Fed meets next week and is still expected to increase rates despite the softening. Earnings Season will take center stage with the Tech Titans releasing their report cards starting next week.
The price of Oil has been fairly buoyant this Summer. Despite the economic slowdown, it keeps holding the $70 level. It’s been running higher this week. Demand is still strong, and supplies are quite tight. World Oil demand is expected to grow by 2.4 Million barrels per day this year. That would take it over 102 Million barrels on average every day, a new record. China accounts for 60% of the gains. China’s daily Oil demand reached an all-time high of 16.3 Million barrels in April. Supplies are not keeping up.
Total Oil supply is forecast to also reach a record high level this year. The problem is, it’s 1 Million barrels less than demand. The Saudi Kingdom just slashed output by 1 Million barrels to a two-year low of 9 Million barrels per day. Russian Oil exports have dropped to less than 8 Million barrels. China and India accounted for over half the total of Russian exports. Both countries are happy to take these supplies at steep discounts.
The United States produces 12 Million barrels per day, back to its all-time high first reached in 2019, before Covid. It continues to dominate non-OPEC+ supply increases, but gains are set to ease from 2 Million barrels per day this year to just over 1 Million in 2024. Growth is slowing in North American shale as those wells have shorter shelf lives. They get depleted fast. Oil was considered the prize in the 20th century. It’s proving to be essential in the 21st as well. Renewables are making serious inroads into total energy supply and consumption. But the fact remains, the World still runs on Crude.
That’s quite a lot I threw your way this week. Thanks for staying with me throughout. It’s really important stuff.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
