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Ukraine - Russia Crisis: For Investors, US Energy Is Most Interesting Sector to Watch

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Investment strategist John Canally recommends abandoning volatile commodities for oil exploration companies poised to benefit from the conflict.

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The geopolitical crisis stemming from the fast-moving events in Ukraine is shocking investors into reexamining their appetite for risk, only days after they had begun to shake off their previous bout of emerging markets paranoia.

Investors spent much of Monday fleeing assets that they considered risky, ranging from Russian stocks (off 15% at one point during the day) and European markets -- the most directly affected -- to US and emerging market equities. The S&P 500 (INDEXSP:.INX) tumbled 0.74%, following the lead of major European markets, which all closed sharply lower.

The winners from the recent volatility -- other than perhaps Russia's Vladimir Putin, channeling the spirits of past Russian expansionists, from Tsarist times to Stalin and Khrushchev -- are those investors who have stubbornly clung to a conviction that commodity markets held upside potential. They proved to be right, if not for the reasons they cited when they established those positions.

Putin's push, as we saw Monday, could have major implications for a wide range of commodities, from gold to grain to, of course, oil and gas.

When uncertainty and even downright panic grips other parts of global financial markets, the tried and true reflex is to buy gold. The price of gold surged 2.2% Monday to set a four-month high at $1,351 per ounce in New York futures trading. The metal is still widely seen as the classic "safe haven" investment in times of turmoil, so it's hardly surprising that it has posted such significant gains. Even if investors don't plan to keep their cash parked there for long, it's a convenient stopgap while investors try to figure out just what is going on in Ukraine and evaluate the risk/reward tradeoff in other asset classes.

Those gains in gold aren't likely to endure. The supply/demand fundamentals simply don't support a higher price, and right now, it's momentum (translation: acute anxiety) that is driving the gains, coupled with the fact that gold was probably oversold in the wake of its 28+% sell-off in 2013.

If the jump in the price of gold had to do with geopolitical uncertainty in general, the moves in other commodities -- like grain and energy prices -- relate more directly to Ukraine's importance to those markets. Every year, Ukraine exports some 3 million tonnes of wheat and other grains, serving as the "breadbasket" for large swathes of Western Europe as well as other areas; the US Department of Agriculture has estimated that the country supplies 16% of total global exports of wheat and corn. A large portion of those shipments are routed through the Crimean port of Sevastopol, the focus of Russia's annexation attempt.

There has been no actual interruption of grain supplies, and there may never be one. But given that Ukraine was on a path to overtake Argentina as a supplier of grain to global markets, the fear of such a supply hiccup -- whether it's due to political interference in commercial transactions or simply to logistical difficulties in getting those supplies to market -- has been enough to propel prices higher.
Wheat prices rocketed 6.8% higher Monday, with wheat for March delivery closing at $6.26 per bushel in Chicago futures trading, while corn futures jumped 1.4% to $4.64 per bushel. Those gains are the largest we've witnessed since the hot, dry weather of the summer of 2012 damaged the domestic corn crop in the US, sending costs for food producers and consumers higher as a result.

The most interesting market to watch, however, is the all-important energy complex. It's here where Putin's aggressive moves to bring Ukraine firmly back into the Russian fold may have some significant long-term consequences -- and offer a new set of opportunities for investors.

Today's Russia is, essentially, a petro-state, relying on crude oil and natural gas for about half of the country's budget, a dependency that has been described as "an oily black hole" for Putin's regime. In the short term, the Russian president's Ukraine gambit boosts his country's economic fortunes: Each dollar that crude oil rises in response to the crisis is money in Russia's coffers. For a country whose economic growth can at best be described as lackluster, that's good news.

It's also unsustainable, as John Canally, investment strategist at LPL Financial points out: "These events might temporarily keep prices high, but eventually global fundamentals will reassert themselves."

That won't happen overnight, but in the meantime, there's an argument for investors to take another look at the US energy sector. "Our own energy renaissance, already underway, may be helped by these events," Canally says. "It bolsters the case for the US to become an energy hub."

Right now, Europe is heavily dependent on Russian supplies of natural gas. True, we're approaching the end of the winter "heating season," but no European government wants to contend with either a supply shortfall or a surge in prices if Putin opts to turn off the taps or otherwise ensure that the supplies to European customers diminish. Putin is taking a calculated risk that sanctions will be minimal because of this.

Longer term, however, the reserves of shale oil and natural gas in the US, which have depressed US energy prices on a relative basis, have transformed the country into the top natural gas producer worldwide. The Obama administration already is pushing forward with attempts to build export markets for some of this new output, approving the construction of new LNG terminals that could be used to displace some of those Russian imports, at least conceptually. True, it wouldn't be as cheap or efficient, but it offers Russia's consumers an alternative down the road.

That's why, if you're looking for a way to react to the minute-by-minute changes in the news coming out of Ukraine, your best option may be to ignore the short-term volatility in commodity prices -- forget trying to short stocks or pick a bottom for the S&P 500, and don't even try chasing commodity price movements.

Instead, take a gander at the energy industry, from oil drillers and service companies to Sempra Energy (NYSE: SRE), which has won Energy Department approval to export LNG from Louisiana. You could even take a chance on some of the smaller exploration and production companies most active in the domestic shale oil and gas arena -- while shunning the likes of Exxon Mobil (NYSE:XOM) and BP (NYSE:BP), both of which are heavily exposed to Russian ventures. "Energy stocks that are focused on North America will benefit more," argues Canally.

Editor's Note: This article by Suzanne McGee originally appeared on The Fiscal Times.

For more from The Fiscal Times:

The Race for Arctic Oil: Advantage Russia Vs. US

Russian Ties to Ukraine Go Much Deeper Than Gas

Why Are Companies Just Sitting on Mountains of Cash?


Follow The Fiscal Times on Twitter @TheFiscalTimes.
No positions in stocks mentioned.
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