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Daily Intelligence Briefing – April 16, 2018
FEATURED TOPIC: WHAT TO EXPECT FROM THE NEW ECONOMIC WARFARE AGAINST RUSSIA
MRP’s recent DIBs report on Russia gave an overview of the latest sanctions imposed by the U.S., and what that meant for Russia’s economy in general. Today’s report dives a little deeper into the rationale of the sanctions and highlights sectors that are getting impacted.
As noted last week, Russia’s economic star has been on the rise and the country is finally enjoying a period of macroeconomic stability and growth, after emerging from a painful recession. If the intent had been to put pressure on the Russian economy, officials in Washington would have directly imposed sanctions on institutions such as Gazprom, Lukoil and Rosneft in the all-important oil & gas sector, or Sberbank, the nation’s largest bank.
But, the U.S. chose not to exercise the “nuclear option” -– at least for now –- preferring instead to go after oligarchs in Putin’s inner circle and their business empires as well. In doing so, the U.S. treasury highlighted the extent to which Russian banks, companies, oligarchs and officials are exposed to the dollar and the might of U.S. economic warfare.
Despite the rise of other currencies such as the Euro and Renminbi, the U.S. dollar remains the dominant currency around the world, with 50% of global trade still conducted in dollars and nearly two-thirds of global currency reserves being held in dollars. This dominance has made it possible for the United States to weaponize its currency against those that act counter to its wishes.
Since emerging from its debt crisis in 1998, Russia has become integrated into global supply chains and finance. Russian entities have tapped into European and U.S. capital markets for funding, with many of them listing shares on international stock exchanges; Russian companies engaged in resource extraction have benefited from growing global demand for commodities. That integration into the global markets is what makes Russian conglomerates, and ultimately the Russian economy, vulnerable to this new breed of U.S. sanctions.
The sanctions were announced on Friday, and by Monday the impact was striking. The share prices of Rusal and its parent company EN+ Group, both sanctioned for their material connection to Oleg Deripaska, fell roughly 50%. Clearstream, a key component of investment market infrastructure, announced it would stop processing transactions in those securities, and the London Metal Exchange suspended trading of Rusal’s aluminum.
Meanwhile, commodity traders, clients and other entities transacting with the sanctioned companies found related payments blocked as banks too sought to steer away. Apparently, very few banks want to risk handling funds that could bring unwelcome attention from American authorities, especially since the U.S. Treasury stipulated that foreign persons and entities would face “consequences” if they “knowingly facilitate significant transactions, including deceptive or structured transactions, for or on behalf of any person subject to US sanctions with respect to the Russian Federation, or their child, spouse, parent, or sibling”.
One can think of Oleg Deripaska as the poster boy for this round of sanctions. His name and nearly all of his companies were on the sanctions list, including Rusal.
The swift crippling of Rusal’s aluminum business and stock price demonstrated to Oleg Deripaska and other Putin cronies how punitive this form of sanctions can be if the U.S. decides to go after their personal fortunes. One reason Putin has been able to stay in power is his ability to make his friends rich. But if their association with the Kremlin confines them to only doing business in Russia, Putin’s patronage could become a problem they want to get away from, which would weaken Putin. Most of the oligarchs have assets and business interests outside of Russia, which means they are exposed.
One sector that stands to benefit is aluminum. After top exchanges said they would stop accepting metal from Rusal, buyers scrambled to find new supplies sending aluminum prices soaring over 15% to a six-year high of USD $2,326 a ton on April 13th. Rusal, which gets 80% of its business from international sales, reported nearly $10 billion of sales in 2017, with about 15% coming from the United States — its second largest market after Russia. The removal of the Rusal supplies and the new 10% tariff imposed by the U.S. on some aluminum imports may continue to put upward pressure on prices, mostly to the benefit of U.S. aluminum producers.
In contrast, banks with loans to the companies on the sanctions list are exposed. For example, the share price of Sberbank (SBER) dropped more than 20% on the first trading day after the sanctions were announced. With half of Russia’s retail deposits, Sberbank tends to be more sensitive to the Russian economy than to external markets. However, as Russia’s biggest lender, it is vulnerable to sanctions against other Russian companies to which it lends. If a hard-hit company like Rusal has a loan from Sberbank, that loan could become non-performing, hurting the bank’s balance sheet. Rusal has already warned that it will likely experience a technical default on some of its debt.
Outraged by the sanctions, Russia’s parliament has drafted legislation to restrict U.S.-made imports, which amounted to about $12 billion in 2017. The draft law proposes banning some agricultural, industrial, and pharmaceutical products which Russia can obtain elsewhere; barring cooperation on atomic energy and aerospace; and stopping U.S. firms from taking part in Russian privatization deals. These measures will be discussed in Russia’s lower house later this month.
In the meantime, markets, banks and investors are bracing themselves for more possible action from the administration. Indeed, Putin’s unflinching support of Syrian leader Bashar-Al-Assad, even in the wake of Friday night’s military strikes – conducted by the U.S., France and the UK in response to the Syrian leader’s reported use of chemical weapons on civilians – has the U.S. already considering additional sanctions on Russia.
In January, the U.S. Treasury published a list of 206 senior Russian political figures, oligarchs and other persons of interest. Last week’s sanctions targeted 24 individuals on that list. This succinct chartdetails who they are, how they’re connected, and the US Treasury’s allegations against them. There are potentially a further 182 names to go, if the U.S. chooses to follow the same strategy, the most vulnerable being those with businesses that derive most of their revenues and funding outside Russia. Here’s the full list of 206 names.
HERE IN THE MEANTIME are some articles relating to this featured topic a(the stories are summarized in the POLITICS & POLICY section of today’s report):
- Russia Sanctions – This time, sanctions on Russia are having the desired effect
- Russia Sanction – Sanctions have sent aluminum soaring
- Russia Sanction – Russia lawmakers draft list of U.S. imports that could be banned
CHART: Russian Equities (RSX) vs Aluminum ETN (JJU) vs OIL ETN (OIL) vs S&P 500 (SPY)
OTHER DISRUPTIVE CHANGE:
- Economics and Trade:
- Inflation – Inflation: This Time It’s Real
- Banks – E-brokers and banks finally have something to cheer about: Volatility boosts trading
- Logistics – Why Amazon May Not Win The Same-Day Delivery Race
- Ags – Trade war backfire: Steel tariff shrapnel hits U.S. farmers
- Lithium – Surging Demand for Lithium Spurs Interest in European Mines
- Oil – OPEC Near ‘Mission Accomplished’ as Oil Glut Vanishes, IEA Says
- Oil – Oil prices vulnerable to ‘super spikes’ again as geopolitics heat up
- Oil – IEA Sees OPEC Output Dropping Near 3-Year Low on Venezuela Woes
- Energy & Environment:
- Power – This coal power plant is being reopened for blockchain mining
- MedTech – The FDA just opened the door to let AI make medical decisions on its own
- Healthcare – Doctor shortage could exceed 121K by 2030
- Gum – Chewing Gum Sales Are on a Downward Trajectory
JOE MAC’S MARKET VIEWPOINT
- Joe Mac’s Market Viewpoint: A Review of MRP Themes
- Joe Mac’s Market Viewpoint: Beyond the HOUSING HEADWINDS
- Joe Mac’s Market Viewpoint: The Coming Value Rotation
- Joe Mac’s Market Viewpoint: Beyond the BOND BUBBLE
- Joe Mac’s Market Viewpoint: Contrarian Crude Call
Electric Utilities (L)
TIPS (L) / Long-Dated UST (S)
Industrials & Materials (L)
U.S. Financials & Regional Banks (L)
ASEAN Markets (L)
Oil & U.S. Energy (L)
U.S. Homebuilders & Construction (L)
France (L), Greece (L)
U.S. Healthcare Providers (S)
Gold & Gold Miners (L)
Robotics & Automation (L)
Video Gaming (L)
Value over Growth (L)
About the DIBs: MRP focuses on identifying transformational change in the global economy and offering an investment thesis whenever an opportunity arises that has not yet been recognized by the market. The DIBs are MRP’s compilation of articles and data from multiple sources on subjects reflecting disruptive change that have potential investment implications for an industry or group of securities. We share these with our clients who may already have or may be considering exposure in the industries affected. The subjects change daily and constitute an excellent update on featured topics.
US Job Openings Fall More than Expected in February
The number of job openings in the United States fell to 6.052 million in February 2018 from a downwardly revised 6.228 million in the previous month and below market expectations of 6.173 million. There were less open positions in accommodation and food services (-91,000), construction (-56,000), and wholesale trade (-38,000). Meanwhile, job openings increased in finance and insurance (69,000) and state and local government education (31,000). The number of job openings decreased mostly in the West region (-148,000). TE
S&P Revises Japan Outlook to Positive
S&P Global Ratings revised its outlook on Japan to positive from stable and left the country’s long-term foreign currency unsolicited sovereign credit rating unchanged at A+ on April 13th 2018.
The agency said that nominal economic growth exceeding 2%, alongside negative effective real interest rates, would allow the sovereign’s relative debt burden to stabilize sooner than previously expected. S&P added that the rating reflects the country’s formidable external position, prosperous and diversified economy, political stability, and stable financial system. TE
Aluminum Jumps to 6 Year High
The price of aluminum has surged almost 16% since Friday April 6th when the United States announced sanctions on Rusal, second biggest aluminum producer in the world controlled by Russian oligarch Oleg Deripaska. The commodity was trading at a six-year high of USD 2,326 a tonne on April 13th. TE
Soybeans Hits 14-month High
Soybeans increased to a 14-month high of 1075 USd/Bu. TE
Inflation – Inflation: This Time It’s Real
Inflation is hitting the Fed’s 2% target—and it’s not just about the base.
A year ago, the mobile-phone price wars were dragging down indicators such as the consumer-price index – Despite unemployment down near 4%, inflation was falling short of the central bank’s 2% target.
The CPI for March showed a year-on-year increase of 2.4%, while the core measure that excludes food and energy prices was up 2.1%. The dip from a year earlier lowered the base upon which that change was based, so simple arithmetic meant a larger increase from that depressed starting point.
The Fed’s preferred inflation measure, the core personal consumption expenditures deflator, should also reach the central bank’s 2% annual goal when the March data are released later this month.
More importantly, higher inflation is being reflected in forward-looking indicators. The New York Fed’s Underlying Inflation Gauge moved up to 3.14% in March from 3.07% in February.
In addition, BCA Daily Insights points out, inflation break-evens derived from the Treasury inflation-protected securities market showed inflation expectations for the next 10 years and for five years in five years from now were at 2.1%, just above the Fed’s target. Barron’s
Russia Sanctions – This time, sanctions on Russia are having the desired effect
Despite the rise of China and the growth in economic prosperity across the globe, the US — and, importantly for sanctions, the dollar — remain dominant. Approximately 50% of global trade is still conducted in dollars and nearly two-thirds of global currency reserves are held in the US currency. During the past two decades, the US has taken advantage of its economic and financial hegemony, and successive administrations have sought to “weaponise” the dollar against those acting counter to its interests and beliefs.
Since Russia emerged from its debt crisis in 1998, its banks and corporates have benefited from globalisation. The former have tapped the deep capital markets in Europe and the US for funding, and corporates, particularly in the extractive sector, have benefited from global demand for commodities and have listed their shares in London, Hong Kong and New York.
Russia has thus become integrated into global supply chains and global finance. But just as globalisation has benefited Russia, this integration presents a vulnerability if the markets in which these companies operate are turned against them. The extent to which Russian banks, companies, oligarchs and officials are exposed to the dollar means that no bank, whether US-based or not, will want to risk handling funds that could bring unwelcome attention from American authorities.
But perhaps most concerning for markets, banks and investors, and therefore damaging for Russia in the long term, is the uncertainty surrounding what future action might be taken by a US administration that is clearly willing to use far-reaching economic warfare to counter its adversaries. FT
Russia Sanction – Sanctions have sent aluminum soaring
The price of aluminum has surged 10% since the United States slapped tough new sanctions on Rusal, a leading metal producer controlled by Russian oligarch Oleg Deripaska.
Under the sanctions announced Friday, Americans are generally prohibited from doing business with Rusal, and people of other nationalities could face sanctions themselves if they facilitate transactions for the firm.
Rusal produces 7% of the world’s aluminum. But buyers, business partners and commodity exchanges are now scrambling to sever ties with the company. Its shares have plummeted 56% since the sanctions were announced.
Aluminum prices can be volatile, and short term price hikes won’t do much to affect the price of consumer staples. If sustained, that price hike could push up the cost of making a range of industrial and consumer products, including cars, airplanes, soda cans and pharmaceutical packaging. CNN
Russia Sanction – Russia lawmakers draft list of U.S. imports that could be banned
Russia’s lower house of parliament is to consider draft legislation to ban or restrict a list of U.S. imports, reacting to new U.S. sanctions on a group of Russian tycoons and officials.
The sectors listed in the draft which could be subject to bans or restrictions include U.S.-made software and farm goods, U.S. medicines that can be sourced elsewhere, and tobacco and alcohol. It gives the government the power to ban cooperation with the United States on atomic power, rocket engines and aircraft making, and to bar U.S. firms from taking part in Russian privatisation deals.
Large-scale restrictions on U.S. goods and services would hurt American firms but could also cause significant disruption in Russia, where consumers flock to McDonald’s restaurants, fly on vacation in Boeing jets, and use Apple phones.
Western companies, including Ford Motor Co, PepsiCo and Coca-Cola’s bottler Coca-Cola HBC, have invested billions of dollars since the fall of the Soviet Union to set up local production in Russia. R
Banks – E-brokers and banks finally have something to cheer about: Volatility boosts trading
The S&P saw average intraday volatility of 1.38 percent in the first quarter, more than three times that of the fourth quarter and the highest level since the first quarter of 2016. Stock market volatility is expected to be a big help to the trading operations of the money center banks, which began reporting earnings Friday morning. It will be a big help to the e-brokers, and to stock exchanges as well.
Schwab reports quarterly earnings Monday, the first retail broker to do so. Most of these firms are sitting on double-digit stock price increases this year, at a time when the S&P 500 is flat.
The primary factor driving this surge is volatility. The S&P saw average intraday volatility of 1.38 percent in the first quarter, more than three times that of the fourth quarter and the highest level since the first quarter of 2016. Another contributor has been the very strong retail interest in trading bitcoin and cannabis-related companies. Higher interest rates are another important factor. Most e-brokers have banks whose profitability improves as rates go up.
Bottom line: Net revenue will likely be at record levels. And the volatility looks like it is continuing.
E-broker stocks roar
Interactive Brokers: up 22 percent
TD Ameritrade (Scottrade): up 19 percent
ETrade: up 18 percent
Schwab: up 2 percent CNBC
Logistics – Why Amazon May Not Win The Same-Day Delivery Race
Roadie — a startup that gets everyday folks to deliver packages while on their way to wherever they’re already driving — has notched a lot of oddball same-day delivery jobs that Amazon doesn’t do.
Around 80%-85% of its shipments are same-day affairs, fueled partly by individuals with curious packages, but mostly by bigger businesses. And Roadie, which provides Kroger grocery delivery in select areas and brings lost luggage to Delta Air Lines customers in about 40 markets, is not alone.
Roadie rivals Instacart and Deliv have separately joined forces with Walmart, Costco, Kroger, Macy’s and Best Buy on same-day shipping. Target even went so far as to acquire Shipt for $550 million.
The driving force behind this latest retail trend, as ever, is Amazon. Its Prime same-day delivery service follows a free-shipping perk that is now a de facto requirement for online shopping.
Speedy delivery doesn’t come cheap. Customers could pay anywhere from $5.99 to $9.99 per shipment for the pleasure. But demand continues to mount, which makes it essential for retailers in order to compete in this instant-gratification economy. Same-day delivery is not without major challenges. It’s expensive, for one. Amazon alone will approach $10 billion in absorbed delivery costs this year.
This new trend has been called a $200 billion opportunity for retailers in Europe and North America over the next decade. IBD
Ags – Trade war backfire: Steel tariff shrapnel hits U.S. farmers
Throughout U.S. farm country, where Trump has enjoyed strong support, tariffs on steel and aluminum imports are boosting costs for equipment and infrastructure and causing some farmers and agricultural firms to scrap purchases and expansion plans.
The metals tariffs are also hitting makers and sellers of farm equipment, from smaller firms like A&P Grain to global giants such as Deere & Co and Caterpillar Inc. Such firms are struggling with whether and how to pass along their higher raw materials costs to farmers who are already reeling from low commodity prices amid a global grains glut.
U.S. farmers can ill-afford any loss of sales. U.S. net farm income is forecast to drop to $59.5 billion in 2018 dollars, down from $64.9 billion in 2017, an 8.3 percent decline, according to the USDA.
U.S. competitors Brazil, Argentina and Russia have all raised grain output in recent years, eating into the U.S. share of global markets. Mexico imported ten times more corn from Brazil last year and is set to buy even more in 201
U.S. net farm income is forecast to drop to $59.5 billion in 2018 dollars, down from $64.9 billion in 2017, an 8.3 percent decline, according to the USDA. R
Lithium – Surging Demand for Lithium Spurs Interest in European Mines
Prices for lithium more than doubled to $21,000 a ton in the past two years. Analysts expect the lithium-ion battery market to surpass $90 billion by 2025.
But while European businesses use 25% of the world’s lithium, a group of Chinese companies has secured a potential stranglehold on the Australian and South American mines that produce almost all the world’s battery-grade metal. China’s Ganfeng Lithium holds 20% of an Argentine project. Chinese firm Tianqi Lithium’s has attracted regulator attention in Chile due to its $4 billion bid to buy a stake in SQM, the world’s second biggest lithium producer. Combined, the companies would control 70% of the world lithium market.
For now, the best European candidates for lithium are in Germany and the Czech Republic where companies have successfully mined and produced battery-grade lithium and hope to sell it to the numerous car manufacturing plants dotted around central Europe.
One German firm, Deutsche Lithium GmbH, was recently granted a 30-year mining license and has already scooped out 100 tons of lithium-yielding rock as it fine-tunes its extraction processes. The company said it could eventually mine 15,000 tons a year. Meanwhile, Australian mining company European Metals Ltd. has extracted battery-grade lithium from its mine in the Czech Republic and is finalizing a $400 million pitch to investors to scale up production. WSJ
Oil – OPEC Near ‘Mission Accomplished’ as Oil Glut Vanishes, IEA Says
OPEC is on the verge of “mission accomplished” in its quest to clear the global oil glut that caused the worst industry downturn in a generation. Less than 10 percent of the surplus in oil inventories remains, as OPEC and its partners have cut production by even more than they intended while world demand soars.
Oil futures climbed to a three-year high in New York this week, moving toward $70 a barrel, as political tensions in the Middle East threaten to strain supplies even further. Oil inventories in developed nations are just 30 million barrels above their five-year average, That’s down from more than 300 million barrels when the group started its cuts.
As OPEC gets closer to its goal, Saudi Arabia is increasingly eager to revise the target, arguing that the cuts need to continue to ensure markets have properly rebalanced.
While OPEC members agreed to reduce output by about 1.2 million barrels a day, their actual cut last month was more than 60 percent bigger. The group’s 14 members pumped 31.83 million barrels a day in March, the lowest in almost three years. The 24 members have now cut output by almost 2.4 million barrels a day, more than their combined pledge of 1.8 million barrels. B
Oil – Oil prices vulnerable to ‘super spikes’ again as geopolitics heat up
The long era of too much oil sloshing around the world and low prices is coming to an end, just as global events are heating up crude prices. That means there’s a new higher floor under oil prices as the peak summer demand season approaches, and it also makes the market vulnerable to a “super spike” if there’s any significant supply disruption. Gasoline prices are also vulnerable. They are already expected to hit a four-year high this summer.
Brent crude, the international benchmark, was up 7.8 percent in the past week and was trading near $73 a barrel in the futures market for the first time since December 2014.
Oil’s price also has been firming as Houthi rebels in Yemen have increased a campaign of firing missiles into Saudi Arabia. Another uncertainty is the Iran nuclear deal, which the U.S. may choose to exit in May. Another is Venezuela, where the state oil company PDVSA has seen its production cut in half as its economy teeters.
The other unknown is the U.S. shale production, which has increased as OPEC production decreased. On Thursday, the world’s total oil supply rose by 180,000 barrels a day last month, mainly because of non-OPEC producers.
Saudi Arabia and Russia are expected to try to extend their production arrangement after it expires in December. CNBC
Oil – IEA Sees OPEC Output Dropping Near 3-Year Low on Venezuela Woes
OPEC’s crude production fell to the lowest in almost three years as Venezuela’s woes continued to mount. The size of Venezuela’s production declines are matching those of Saudi Arabia. However, the essential difference is Venezuela’s reduction is unintentional with the Latin American nation’s oil industry suffering from chronic mismanagement.
The collapse of Venezuela’s oil industry is partly a reason OPEC has over-delivered on its pledge to curb supply. The group and its allies including Russia are not only nearing their target of bringing global stockpiles back in line with five-year averages, but are starting to suggest markets may tighten sharply later this year. OPEC’s compliance with its pledged cuts in March rose to a record 163 percent in February.
Venezuela’s oil production last month was 580,000 barrels a day below its reference level of 2.07 million barrels a day. That’s just shy of Saudi Arabia’s 620,000 barrel-a-day cut in March. Venezuela had originally agreed to slash 95,000 barrels a day when it signed the deal.
The Latin American nation’s output capacity is likely to drop to 1.38 million barrels a day by the end of the year, the lowest level since the late 1940s, Paris-based IEA said. Production fell to 1.49 million barrels a day in March from 1.55 million barrels in February, helping boost its compliance rate to 607 percent. B
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