As unfortunate as it is, Russia has decided to attack Ukraine. While it seems to be a geographic conflict, it is actually a financial war in disguise. As I have explained in this article, there is an invisible financial hand behind most of the geo-conflicts, and the Russia-Ukraine war is no different.
If you are an investor, you need to understand how finance plays a role in the current situation so that not only can you safeguard your wealth, but you can also discover potential investment opportunities.
Conventional wisdom tells you that in the midst of a crisis, you should turn to US Treasury investments and Gold as a safe haven, but it is not so simple this time. In this article, I will explain to you why.
Before that, I recommend that you read my previous article, where I talked about the backdrop of this financial war.
#1. US Stocks – Tomorrow Never Dies
First of all, you must understand the biggest winner in the current situation is none other than the US. As they have hoped for and worked towards, the world has forgotten about the Covid-19 pandemic, US inflation, and the rising interest rate, but is instead focusing on the development in Ukraine.
This was designed and carefully set up. Because when the US needs to increase their interest rate, they are very concerned about a crash in their own financial market. With the mess in the European zone, the money is naturally flowing to the US, which is perceived as a safe haven.
But smart money never stays in the form of cash, they need an asset to invest into. Uninformed investors may jump to the conclusion that the safe haven is the US treasury. But it is not necessarily true.
In the current rising interest rate environment, most bonds do more harm than good in your portfolio. The US bond price may go up in the short term due to demand for “parking”, but once the Russia-Ukraine situation improves (which will happen eventually, and probably in the short term), the interest rate will come back to haunt you.
The chart below shows that when the war started, the market’s fear level has reached the extreme and it normally marks the end of the correction for the US stock market. So I believe that US stocks will remain resilient in the mid to long term.
#2. Chinese Government Bonds (CGB) – Safer than the US Treasury
In the US-dominated world of finance, few people talk about China bonds. This is either due to ignorance or unwillingness to accept that there is something safer than the US treasury.
But the fact is that the second-largest bond market in the world with onshore US$18 trillion as of December 2021 is the China bond market.
If you look at the chart below, over the past 6 months, the China bond index has been going up while the US bond index is going down. The financial world has used its money to vote for China government bonds against the US treasury.
Since this is not a familiar topic to most retail investors, I will explain more.
Why are China bonds different?
Unlike their global peers, China tends to operate in its own distinct way. While we all know that the US is planning to raise their interest rate to combat inflation, China is doing the opposite.
In January 2022, China’s central bank cut its key lending rates amidst the economic slowdown with a relentless crackdown and a zero-Covid policy. CGB is attractive to smart money now due to the following three reasons:
- Low correlation
- Chinese Yuan resiliency
- Future institutional demand.
Low correlation – China government bonds are the darling of institutional investors because of their low correlation to other developed market bonds. If you understand portfolio management, we don’t necessarily want high returns for every investment position, rather, we want positions that are not moving in the same direction at the same time. This is called low correlation and the Chinese Government Bond is a perfect fit.
If you want to zoom into numbers, you can refer to the table below. “1” means perfect correlation and “0” means no correlation. You can see that CGB’s correlation to other government bonds is around 0.1 to 0.2 which means they tend to move in their own ways.
Chinese Yuan (CNY) resiliency – From a currency perspective, the Chinese Yuan (CNY) has been steadily going up against the US dollar. As the Russia-Ukraine situation worsens, CNY is appreciating even faster than the US dollar.
So if you invest in a Chinese Government Bond, which is dominated by CNY, not only will you get the bond price and yield return, you will also potentially gain returns from currency appreciations.
If you are a Singapore investor, SGD itself is a strong currency. You can see from the chart below that the Euro currency has depreciated a lot against SGD. If you were investing in Euro bonds, you could have already suffered a total loss.
Future institutional demand: Unlike the US treasury, institutions lack exposure to CGB. This could be due to historical reasons as well as regulatory restrictions. So far, foreign investors only own about 3.5% of China’s onshore bonds.
But things are changing quickly. Foreign demand for CGB has been strong in 2021, with foreign investors buying almost 20% of net CGB supply from Jan to Oct 2021, up from 14% in 2020.
With the inclusion of CGB into the FTSE World Government Bond Index (WGBI), passive funds will have to come in to buy CGB as well. It is estimated that this will attract an average inflow of USD 3 billion per month into the CGB market.
How can you buy Chinese Government Bonds?
For retail investors, there aren’t many choices when it comes to investing in Chinese government bonds. The reasons are simple:
- Bonds are largely an institutional game
- Retail investors cannot access the China bond market directly.
- There was less demand from retail investors for such products in the past
But lucky for us, there is a Chinese Government Bond ETF listed on the Singapore exchange. The ETF is called ICBC CSOP FTSE Chinese Government Bond Index ETF and is managed by CSOP Asset Management. The SGD counter stock code is CYC and the USD counter code is CYB.
While most bonds in the world have lost money, the chart below shows the CGB performance has been very impressive.
#3. The Price of Gold is up – but it may not last forever
In my previous article, I talked about Gold. It is easy to understand why the Gold price has shot up recently due to the Russia-Ukraine tensions. The question is, how much further can it go?
While the gold price hit $2,000 per ounce in 2020 August, I wrote an article, Gold Price Surging: Is It Too Late to Buy Gold Now? I said, “Gold is not safe”. As you can see from the chart below, soon after, gold prices had a free fall and stayed low for nearly 2 years.
Contrary to many people’s beliefs, Gold is a speculative asset rather than a stable asset in today’s context.
As I have discussed in my article “Bitcoin: Is it a good long term investment?”, I explained that the challenge for cryptocurrency is that it is challenging the Dollar System. The same goes for Gold because it is the deadly enemy of the Dollar.
If the US’s objective is to push money so that it flows back to the US Dollar, then the Gold price cannot go too high. Moreover, Russia completely abandoned the US treasury a few years back and replaced it with Gold in recent years. The US definitely doesn’t want to see Russia become rich right?
But there is an interesting twist now. Due to the Russia-Ukraine war, the US and Europe have imposed SWIFT sanctions against Russia. Many people heard about SWIFT but are not sure what it is exactly.
SWIFT stands for the “Society for Worldwide Interbank Financial Telecommunication”. Simply put, SWIFT is a global payment messaging system. When bank A transfers to bank B, they send a “message” in the system to make sure the transaction is securely verified.
SWIFT, as a society for the financial institutions, is supposed to be neutral. But as an open secret, it is controlled by the US to strengthen their dollar system.
Does Putin not know this? Of course, Russia already has their own SWIFT system called SPFS. SPFS was established after the 2014 invasion of Crimea by the Russian central bank. This is currently used by a handful of international banks in Germany and Switzerland linked to Russian banks.
Or they could use China’s version of SWIFT called CIPS (Cross-Border Inter-Bank Payments System), which is used for cross-border payments in renminbi with many countries.
The SWIFT sanction has two immediate impacts:
Money flowing to China – As I discussed in the article How to Invest After the Fed Tapering and Interest Rate Hike, China has already crashed their own stock market and is now waiting for the money to flow in. The recent rally of Chinese Government Bonds (CGB) and report of Chinese payment stocks jump confirmed my theory.
Global Bank stocks took the hit – This occurred either due to their exposure to Russia or it was just bad market sentiment. After all, a unilateral SWIFT sanction against Russia is a wildcard to the financial system.
Here is my advice…
There is much newly developed information about the Russia-Ukraine war and what the western governments will do about it. Try not to make trades based on the news. First of all, the news may be fake or misrepresented, even if it is from “reputable” sources. Secondly, there are too many moving parts.
But this also doesn’t mean that you should simply sit still. Instead, take a look at your portfolio and re-evaluate all your positions. I don’t think this is the time to try bottom fishing speculative stocks, but rather it is an appropriate time to take a defensive position.
If you can understand, the impact of the Russia-Ukraine war itself is a localized event, but what is really causing the market to jitter is the financial intervention led by the US. Admitted or not, we are in a financially interconnected world. That is why even DBS shares in Singapore has fallen more than 10% since the start of the war.
Smart money likes certainty, therefore, I think a big chunk of the money will flow to the US and China and probably to commodities as well. Europe may end up being the poor guy who pays the bill.
Specifically, we need to pay attention to the currency movement of the Renminbi.
I think The Russian-Ukraine conflicts will likely boost the Renminbi’s internationalization. The world has already been searching for a Dollar replacement for a long time. The rise of cryptocurrency was a brutal attempt. For now, Cryptocurrency exchanges Coinbase Global and Binance said that they have no plans to preemptively ban “all” Russians from using their platforms, but that means they have already banned some users. If they give in, the fundamental belief of decentralised finance will be broken.
The high-profile SWIFT episode proves that SWIFT is no longer independent, and raise many nations’ incentive to diversify cross-border payments or trades into the CNY. These will lead to a likely higher demand for CNY in the future.
If the currency stays strong in the foreseeable future, then assets dominated by the Chinese Yuan will be worth investing in.
What do you think? Leave your comment below and discuss.
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