How to prepare for war (in markets)

On Friday, a reader asked me this: How do you prepare for the insanity of war?

It's a good question because when something like a nuclear power invading another country that has a tacit backing from NATO, there's a million places the mind goes.

That's why a plan is so important.

A when the war drums first began to make noise in January, I laid out a plan. I noted there were compelling arguments for a number of trades but some of them had caveats, conditions and other issues. For instance, gold could benefit as a safe haven, but Russia has enormous gold reserves it could sell to prop up the currency.

I flagged the single clearest trade:

The one spot you can count on in the worst environments is the yen.

That preparation was key and that turned out to be the right trade. When the reports hit about an imminent invasion it was the yen that easily bested every other currency.

Being prepared for that meant it wasn't a matter of thinking through the headlines when they it. It was point-and-click. Selling yen crosses was instinctual and fast.

What's next?

Whether it's this war or another one, you need to be thinking about what's next. If Russia demobilizes, the trade is just as simple: Sell the yen. Consider selling oil as well.

If bullets do fly, the moves we saw on Friday will extend. What was important about those moves is that they offered a clear indication of what the market will do if/when the fears are confirmed. I laid out the 'war basket' here. I'm certainly open to more trade ideas around it and would appreciate any of those in the comments. Again, whatever it is; you need to be quick and confident in the execution. If not, there's nothing wrong with going to sidelines.

If the bullets fly, there are a multitude of things to watch, including the ferocity of the strike and public comments from Putin/Zelensky/Biden/EU officials. However there's one big response and I expect it will be the second major trade:

Will the US and Europe sanction Russian oil & gas?

I don't believe they will because that's equivalent to Europe sanctioning itself. They need the oil and gas that Russia is selling. While blocking it would hurt Russia, it would arguably hurt their own economies just as much. Moreover, all 27 EU countries would need to agree and that's a difficult task at the best of times.

That said, it's an unknown.If the first round of sanctions come out and it doesn't involve oil and gas (though there might sanctions against Gasprom individuals), I expect it to hurt oil/gas prices. Of course, that would be coming off a big spike. We would also see some of the war basket reverse.

At the end of the day, a war between Russia and Ukraine would be unimaginably awful from a human perspective but economically, it's not globally significant in all but a few commodities Commodities Commodities are assets that are either naturally grown or occurring in the environment. Most commonly this includes precious metals such as gold, silver, and palladium.Beyond metals, commodities can also focus on agricultural or industrial goods that are central to manufacturing or other sectors. This includes crude oil, copper, wheat, and others.Relative to other assets, commodities are an extremely complex form of investment, with many similarities and differences to existing products.Commodit Commodities are assets that are either naturally grown or occurring in the environment. Most commonly this includes precious metals such as gold, silver, and palladium.Beyond metals, commodities can also focus on agricultural or industrial goods that are central to manufacturing or other sectors. This includes crude oil, copper, wheat, and others.Relative to other assets, commodities are an extremely complex form of investment, with many similarities and differences to existing products.Commodit Read this Term (perhaps wheat). It's more of a question of sanctions. If the sanctions aren't extremely harsh for the Russian economy, then it won't be that meaningful for Russia (with caveats).

Beyond oil an gas, there are others to consider:

Kicking Russia out of SWIFT would also be enormous, almost equal to harsh sanctions on oil and gas; and in some ways worse. SWIFT is supposed to be non-political but it's an option. Perhaps telling is how often Biden has mentioned 'swift' retaliatory sanctions. If that's the case, stay away from risk assets. (Update: A report says SWIFT sanctions are off the table)

If the sanctions are on individuals -- including Putin -- and even on major companies, I think some of the war kneejerk reactions reverse. That said, be careful of sanctions on major Russian banks. The top three are Sberbank, VTB and Gazprombank.

On Nordstream 2, I'm not entirely convinced it matters. If Russia manages regime change in Ukraine, it can use that pipeline capacity to largely replace Nordstream 2.

One option that's also doing the rounds is blocking the export of semiconductors to Russia. I don't think that's consequential either.

However, there's some combination of the above sanctions that will draw Russia's ire. They're not without options to hit back via sanctions and export controls, something outlined by Dmitri Alperovitch.

• The US imports 90% of neon supplies from Ukraine, which Russia could stop
• Russia exports some of its own chips
• 35% of global palladium is from Russia
• Russia is a powerhouse in global titanium exports which are particularly valuable in aviation
• Two-thirds of global amonium nitrate production comes from Russia, an important fertilizer
• Russia can block exports of its oil and gas
• Russia could provoke the US by exporting arms to Iran
• Endless possibilities around electronic war, hacking, manipulation etc

As you can see, there's a long list of possibilities here and these things can spiral. A leaked report last week said NATO countries were considering 'dynamic sanctions' so the first actions won't necessarily be the last ones.

Add it all up and the risks will be very high. There's nothing wrong with watching from the sidelines. Trading around war is one of the toughest things to do.