[This blog post is an excerpt from a commentary published last week at www.speculative-investor.com]

The war between Russia and the NATO-supported Ukraine that began almost exactly three years ago with Russia’s invasion of its neighbour, is one of the more stupid and unnecessary wars of the past century involving the US and/or Europe. It’s likely that this war never would have begun had there been formal acceptance on the parts of the major Western powers that Ukraine would remain neutral, that is, that Ukraine would never be part of NATO. Instead, the push to make Ukraine part of NATO that began in 2008 continued, with the result that millions of Ukrainians have been killed or lost their homes and a lot of Ukraine’s infrastructure has been destroyed. With negotiations now underway between the US and Russia governments, what are the chances that this unnecessary and devastating conflict will end within the next few months?

The short answer is that we can’t quantify the chances, but it’s clear that while it won’t be easy to arrive at a settlement there are strong incentives for both sides to end the fighting. The incentives for Ukraine and NATO are:

1) Stop the loss of Ukrainian lives and property.

2) End the costly transfer of military support to Ukraine — support that is achieving nothing other than prolonging the agony.

3) Prevent Russia from gaining more of Ukraine than it already has, the reality being that the longer the war goes on the more Ukrainian territory will be lost and the closer Ukraine will be to a complete military collapse.

4) Prevent Russia from becoming a bigger military threat to Europe. A large part of the official justification for NATO’s involvement in the war was to prevent Russia from threatening other parts of Europe, but at the outset of the war it was clear that Russia posed no military threat whatsoever to NATO. This was evidenced by the incompetence demonstrated by Russia’s armed forces during the first six months of the war. However, one of the unintended and ironic consequences of this war is that it has resulted in Russia’s military becoming much larger and more capable than it was, that is, it has resulted in Russia becoming a much bigger threat than it otherwise would have been. Furthermore, it’s likely that the longer the war continues, the stronger Russia will become militarily.

5) For the Trump Administration, there is the incentive of making good on a campaign promise and the fact that if the war were to continue beyond this year it would become as much Trump’s war as Biden’s war.

The Russian government also has incentives to bring the fighting to an end. They are:

1) End the massive transfer of resources from the broad economy to the war effort. Although Russia’s government has taken steps to keep a lot of the war-related costs off its own books, the war is creating major problems for the Russian economy. The most visible of these problems is rapid price inflation, which is causing the central bank to maintain its targeted interest rate at 21%. The longer the war goes on, the greater will be the wealth destruction within Russia. Putin almost certainly realises this.

2) End the sanctions that are making it more costly for Russian companies to export and limiting Russians’ access to imports.

3) Reduce the political risk for the current leadership. The longer the war goes on and the more distorted Russia’s economy becomes as a result, the greater the risk to Putin.

The incentives are there, but ending the war still will be difficult because the only deal that will be possible now will be worse, from a Ukrainian/Western perspective, than the deal that was rejected by Ukraine, at the behest of the US and the UK, a month after the war started. Increasing the degree of difficulty is that the bulk of the analysis of the war disseminated by the Western media is unrealistic. According to much of what is seen/read in the West, if ‘we’ can keep the costly military support for Ukraine going for a little longer, then Russia may be defeated. If not, then the Russian expansion won’t stop with Ukraine.

For the West, we think that being realistic involves accepting that:

1) Ukraine will never become part of NATO.

2) There will be no NATO ‘peacekeeping’ troops in Ukraine.

3) Most of the Ukrainian territory that has been taken by Russia up to now will stay with Russia.

And for Russia, we think that being realistic mainly involves accepting that Ukraine, as an independent country, will be free to elect its own government and maintain its own military. Also, although Russia will not accept Ukraine being in NATO, it may have to accept Ukraine being in the EU.

Hopefully the war, and along with it the bloodshed and destruction, will end within the next few months. Shortly after it does end, the rebuilding of Ukraine will begin. The rebuilding effort will, we think, be bullish for most industrial commodities.

[This blog post is a brief excerpt from a recent commentary at www.speculative-investor.com]

We get the impression that some major sentiment extremes are close. In particular, we appear to be at/near peak optimism about the US stock market and the US dollar, peak pessimism about the US T-Bond market, and peaks in the expected effects of Trump’s policies on US economic growth and inflation. These sentiment extremes are inter-related, in that the very popular view that Trump’s policies will drive US economic growth and inflation upward has magnified the decline in the T-Bond price (the rise in the T-Bond yield), which has, in turn, magnified the rally in the US$.

In the T-Bond market, an intermediate-term reversal is likely during the next month. Possible catalysts for the reversal are more evidence of weakness in the US labour market, a surprisingly low CPI or PCE number, a downside breakout in the oil price, an announcement by the Fed that it is ending QT and a steep pullback in the stock market, but note that with such a high level of general bearishness about the T-Bond’s prospects it won’t take much to bring about the initial ‘turning of the tide’.

At around the same time as or soon after the T-Bond price reverses upward, the US$ should begin to weaken on the foreign exchange market. Further to the comment we made above, this is because it was the rise in the T-Bond yield that extended the US dollar’s rally from its September low to the point where it recently made multi-year highs against most other currencies.

The US stock market (the SPX) also could make an intermediate-term reversal soon, although for two reasons there is a realistic chance that the stock market’s inevitable reversal will be delayed despite the apparent sentiment extreme. One is that the stock market could be given a boost by declining interest rates after the T-Bond price begins to trend upward. The other is that the passive investing funds that now dominate the stock market will continue to support equity prices as long as there is a net flow of money into these funds, and there probably will be a net flow of money into these funds until the economy becomes significantly weaker.

The upshot is that the stage is set for some important trend reversals in the financial world. What we are now awaiting is evidence of reversal in the price action.

[Below is a brief excerpt from a commentary published at www.speculative-investor.com on 22nd December 2024]

Interest rates are always among the most important determinants of currency exchange rates, but over the past two years they have dominated. We cite the following two charts as evidence.

The first chart compares the US$/Yen exchange rate (the black line) with the yield on the US 10-year T-Note (the green line). This chart only illustrates the strong positive correlation between these two markets over the past two years, but the relationship has existed and has been tracked at TSI — normally via a chart that compares the Yen with the price of the 10-year T-Note — for much longer.

The second chart compares the Dollar Index (the black line) with the yield on the US 10-year T-Note (the green line).

These charts show that over the past two years the US$ has strengthened against other fiat currencies whenever the US 10-year T-Note yield has risen and weakened against other fiat currencies whenever the US 10-year T-Note yield has fallen. The relationship operates on a trend basis rather than a daily or weekly basis, although it was evident last Friday when a slightly lower-than-forecast Personal Consumption Expenditures (PCE) Index prompted a dip in the T-Note yield, which, in turn, prompted a pullback in the US dollar’s exchange rate.

The overarching message being sent by the above charts is that for the US$ to continue strengthening, the US 10-year T-Note yield will have to continue trending upward. This is unlikely, because we probably are now seeing a sentiment peak related to the expected inflationary effects of Trump’s policies, US economic strength, US stock market outperformance and Federal Reserve ‘hawkishness’. What we haven’t seen yet are any signs in the price action that the trends of the past 2-3 months have ended.

[This blog post is an excerpt from a recent commentary published at www.speculative-investor.com]

The phrase “Drill baby drill” has been around for a long time, but Trump embraced it during his recent campaign to describe the approach to drilling for oil that would be taken by his administration. What will be the likely effect on the oil price of this approach to oil industry regulation? The short answer is: The effect probably will be minor. For a longer answer, read on.

One reason that the effect of this new approach won’t be substantial is that for all its words to the contrary, the Biden Administration did very little to hinder oil drilling. Therefore, the Trump Administration’s “Drill baby drill” approach will not constitute a major change.

The second and most important reason is that in the absence of regulatory roadblocks the actions of the oil industry will be determined mainly be the oil price. It’s reasonable to expect that drilling activity would ramp up if the oil price were to make a sustained move above $90/barrel, but it’s also reasonable to expect that drilling activity would be slowed if the oil price were to make a sustained move below $60/barrel. Therefore, Trump’s opinion that in the absence of regulatory obstacles the oil industry will drive the price down to very low levels is not plausible.

The reality is that although the oil industry is notoriously undisciplined, due to what transpired over the past ten years the one thing that will instil discipline in the future is a low oil price. In the future, an oil company CEO who continues to expand, or more likely fails to cut, production in response to sustained weakness in the oil price probably won’t keep his/her job.

It’s therefore likely that the future response of US-based oil producers will act to keep the oil price in a wide range. That is, it’s likely that in the absence of other influences the future supply response of the US oil industry will create both a ceiling and a floor for the oil price.

Of course, there will be other influences, one of the most important of which will be the actions taken by OPEC+. OPEC+ has about 5 million barrels/day of spare capacity that could be brought on line relatively quickly and cheaply. This represents a bigger threat to the oil price than the “drill baby drill” policy in the US.

In all likelihood, OPEC+ will act similarly to the US oil industry and only increase its production in response to a sustained rise in the oil price to a much higher level. However, there are plausible scenarios under which OPEC could ramp-up its production despite weakness in the oil price. It has done so in the past with the aim of creating financial problems for its competitors in the West and forcing these competitors to reduce production. It could do so again for this reason or because the Saudi leadership does a deal with the Trump Administration that involves guarantees of security/weapons in exchange for a price-suppressing boost to oil production.

Our view at this time is that a much higher oil price is a realistic possibility for 2026-2027, but that the oil price will spend the next 12 months in the $60-$90 range. Furthermore, whereas it probably would take a war-related supply disruption to push the oil price well above the top of the aforementioned range, a move to well below the bottom of the range could result from either OPEC ramping-up production for the reasons mentioned above or a severe recession.