Covid, Ukraine and inflation; but upsides abound if you know where to look

Despite weak sentiment and perhaps similarly weak leadership, there is plenty of reason for investors to be upbeat.

Proactive Published 22/04/2022

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When it comes to a grab-bag of potential market shocks, it’s hard to imagine a convergence of events quite like those we’re seeing now.

An era-defining pandemic seems to have tag-teamed with a war that looks like it's settling in for the long haul, dragging the global economy along for the ride.

The geopolitical concerns don’t stop in Europe, either, with the winds of change blowing on regional relationships – including with our biggest trading partner – in directions that are bound to impact the markets.

Rapidly evolving corporate concern about climate change, sprinkled with some disquiet about sovereign risk and supply chain issues (see above), have driven some commodities – battery components for electric vehicles is the oft-cited example – to record highs.

Inflation looks to be on the way up and is likely to take interest rates with it in the next quarter.

Fuel is soaring, with grocery prices to follow, and there are reports from across the ditch that New Zealanders are buying groceries from Australia online because domestic prices are so high – perhaps a sign of things to come.

Meanwhile, here in Australia, we are two weeks into a national election campaign that’s big on scare tactics and short on policy.

Of course, there are always silver linings where the markets are concerned, and plenty of those abound at the moment.

In this market wrap, we look at prevailing local, regional and global trends affecting growth and commodities as we round out the first quarter of 2022.

COVID-19 – don’t bang your head on the way out

In terms of shocks, there’s little left that COVID-19 can do to shock the market. After two years it’s a known quantity, and the worst of its impacts on the markets – lockdowns and restrictions – seem to be on the way out.

Along the eastern seaboard, consumers and businesses are open to the idea of living with Covid, with Victoria – home of the world’s longest lockdown – abandoning the close contact isolation rule just this week.

In WA, home to our resource industry, things are a heartbeat behind. Close contact restrictions are still in place, but the opening up of the border to the rest of the country has seen the business community breathe a sigh of relief.

“The re-opening of the border has allowed for greater access to labour for some of the core service providers to the mining industry, including drill operators, field assistants and laboratory scientists,” said Shaw and Partners analyst Davide Bosio. “But there are still shortages and pressures in all industries because of inventory.

“The availability of people in WA due to isolation requirements is still impacting workforces – this is affecting all sectors, not just mining.

“We’re also seeing significant inflation and cost pressures for all materials – steel, concrete, timber, glass – which impacts all the way through to business and the consumer.”

Geopolitics – Russian fuel and Chinese components

A joint statement by G7 leaders on Wednesday spoke of “significant” long-term economic damage to the Russian economy caused by sanctions imposed for its invasion of Ukraine.

White House press secretary Jen Psaki has said that Western sanctions have set Russia back 30 years in economic terms.

For its part, Russia today reacted to ongoing US sanctions by slapping a travel ban on a slew of blue tick Americans including Mark Zuckerberg and Kamala Harris.

But the wider global impacts are troubling, with Germany planning to ban Russian oil and gas imports by the end of this year.

“The conflict is playing itself out in real-time – as things happen, they are reported live, and our markets have been quite reactive and responsive to what’s happening on the ground in Ukraine,” said Bosio.

The other piece of the puzzle is the domestic relationship with China, and our dependence on it for brown market items – manufactured goods like consumer electronics.

“China is obviously extremely significant for what happens in Australia,” said Bosio. “The political relationship with China is poor and that’s going to have long-term consequences for our markets.”

“There’s a massive opportunity and a global shift away from these two powers, China and Russia, and the current geopolitical situation has made it plain how important diversity of supply is.

“Europe and the US are looking to diversify away from Russian energy, and reduce reliance on China and Russia, which currently supply circa 40 to 50% of the world’s critical minerals. The dependence on those countries for such vital commodities – in electrical componentry of industrial machinery, vehicles and the like – is a major concern globally.”

Critical minerals – a generational shift or a bubble?

Bosio sees the critical mineral boom as a generational shift: “It’s very hard not to see a world where the price of battery metals only gets stronger and demand heightens.”

“It’s not just a shift to EVs, but a technological shift, and we are at the start of it,” he said. “The push away from the reliance on fossil fuels as a source of energy is no longer an aspirational endeavour – it’s driven by business leaders around the world.

“That said, manufacturers need to put their foot on long-term supply, because without certainty of costs, supply and scale, the whole thing falls down.

“What’s apparent is it’s becoming harder to find Tier 1 jurisdictions and Tier 1 size and scale projects that satisfy the need for those metals and that’s why we’ve seen so much strength in those base metal prices.”

There was a caveat to Bosio’s confidence in the strength of certain trendy commodities though, which was shared by Alto Capital investment manager Tony Locantro.

“Investors flocking to those sectors need to be conscious of bubbles,” Bosio said. “Even though the theme is evident and real, one has to be cautious of the market moving too quickly, because these things don’t go up in straight lines.”

The message is that this sector has a long way to play out, so invest wisely, consider the quality of what you’re putting your money into and watch the market for signs it might be getting ahead of itself.

What’s a good bet?

“In the small caps arena lithium stocks continue to dominate – the likes of Lake Resources, Liontown, Pilbara and Sayona,” said Tony Locantro, though he pointed to the market cap and warned speculators that the bottom can always fall out.

“If you buy near the top you’ve got to deal with the psychology of it.”

Locantro warned against the “sugar hit” of newsworthy rare earth stocks. “There can be a lot of hype and dangerous trading conditions for the inexperienced,” he said.

The upside might be found in more familiar spaces, such as gold and silver. “The gold price is around A$2,650,” Locantro said. “But there is very little hype in the precious metal stocks, you can still buy junior gold and silver stocks that are great value.

“Any decent discovery is being pounced on, so there’s never a bad time to announce a major discovery.”

Locantro tips biotech as another wallflower at the party that might surprise investors. “In the biotechs there has been a bit of a global rout and a lot of the great biotech stocks are on their knees at present and along with the gold stocks represent huge value.

“Some names I’m buying for clients are companies like Chimeric, Radiopharm Theranostics and Nyrada (ASX:NYR), which is moving towards clinical trials of a cholesterol drug but has had a manufacturing delay due to the fact that it’s in Shanghai,” he said.

“I’ve been aggressively buying junior biotech stocks and continued to accumulate gold while I watch the EV thematic play on – biotechs provide a similar risk-reward to exploration stocks so if you get into biotechs at the right time, you’re going to do well.”

How will inflation impact investment?

Shocks usually frighten markets, but surely when there has been this much talk about inflation and its attendant interest rate rises, it’s hardly a shock.

Growth, consumption and demand are strong, costs are spiking and the pre-conditions for inflation are there for all to see.

“This is something that has been on the horizon for some time and has been getting a lot of attention,” said Bosio.

“Investors are digesting what it means, but I think future rate rises are probably not going to surprise too many people. It does feel like our rates have bottomed out and we’re now turning to a period where rates will rise.

“Now what that means for investors is key and I think it means a few things.

“The cost of money is going up, which means the cost of funding is also going up, so if you’re invested in certain sectors and shares, you might see a change in their ability to keep financing growth or what their valuations and returns will look like.”

The problem is that when rates go up, higher interest will accrue on the record levels of government debt incurred over the last few years of pandemic bailouts and expenditure.

Countries and governments could then face pressure to introduce policies to curb inflation and pay down that debt, which in turn could, depending on how aggressive the interest rate rises are, bring the potential for recession.

“I don’t’ think any incoming government will go hell-for-leather raising rates,” counselled Bosio. “They have to be quite measured in how they do it, because of how quickly it could flip the other way and start to negatively affect households and businesses.”

Election on the horizon

The election campaign is in full swing, but we haven’t seen the major political parties attempt to differentiate themselves on policy – neither side is making the case for bold change.

Indeed, the Business Council of Australia’s stance on climate is more ambitious than the targets of either of the major political parties.

“I’m not brave enough to call who is going to get up, but neither candidate seems to have major support from the public,” said Bosio.

“We could see people putting in a protest vote for a minor or independent party, which we’ve seen happen before, which ends up with challenges because independents can wield power in a way voters might not have anticipated.

“The flipside to all of this is that our economy is strong and our businesses are performing very well.

“We are moving out of the COVID-19 era of restrictions (even if it’s a bit slower in WA), travel is resuming and we have this very fortunate situation where we are so well endowed with natural minerals.”