Tensions continue to escalate between Russia and the West over Ukraine. Kim Parlee speaks with Marko Papic, Chief Strategist, Clocktower Group, about the likelihood of potential scenarios that may play out, and how equity and commodity markets may react.
Marko, let's just jump right in on what you think can happen. You've put together five scenarios with probabilities, and I have to say I love this chart you brought up with then also market reaction that could happen with those scenarios. So let's bring it up. We've got here with regards to Russia, a full-on invasion, a land bridge to Crimea, the Georgia scenario, limited incursion into Donbas-- and excuse me if I'm pronouncing it incorrectly-- and then a bluff. So maybe just take us through maybe what you think is the most likely, which is a bluff, and then maybe some of the others.
MARKO PAPIC: Yeah. I think it's a very close call. So obviously, a bluff is a 50%, which is kind of saying I have no idea what's going to happen because 50%, it's a bluff, 50% is some sort of war. But it is very difficult to forecast Vladimir Putin's intentions. I've made mistakes myself on that front in the past. And so you have to be, I think, very careful. But I do think that there is a large probability that Vladimir Putin is accomplishing what he intended, and that's why the bluff has those 50%.
And what he wanted is to divide the West, to sow discord between Europe and the United States, and even discord between Kiev and Washington, which we saw over the last couple of weeks with President Zelensky basically coming out and accusing the US of inciting a panic. So there are certain things that Moscow already got out of this crisis, which is positive for them. That said, I would definitely want all investors to be watching very carefully between February 10 and 20th.
That is when Russia and Belarus will have these extraordinarily large military exercises. So if the other side of the probability table does occur, one of the various scenarios of an invasion, that would occur during those 10 days. So let's break out the other scenarios. First of all, a large-scale invasion into Ukraine-- that and building a land bridge to Crimea, honestly Kim, these are both the same thing. They would require over 100,000 troops by Russia to go into Ukraine.
And while Russia does have very, very strong front line troops that will carve through Ukraine like hot knife through butter, the problem is that they will then have to be supplied by backline forces, and those troops are not as well-trained or experienced as the frontline Russian troops, and that's where the casualties would start mounting. It's not the frontline troops going into Kiev or building their land bridge to Crimea, it's the fresh-faced 19-year-old youth driving a truck, carrying toilet papers, and bleeding for the frontline troops.
And that's where the casualties start mounting, that's when the political risks in Moscow start rising, and that's why I signed basically a token 5% probability. Really you could have pushed me to put zero. I don't think that this is going to happen. Now, the one scenario that I am afraid of, and that I think the markets should be afraid of, is the 2008 Georgia scenario. As you can see, there's 30% probability of that. That's a really dangerous scenario, Kim, because for the first week or two of that conflict, it looks like a full-scale invasion.
Russian troops are outside of Kiev. You have Russian Air Force attacking various Ukrainian airfields across the entire country. It looks like a full invasion, only for the Russians then to back off, and capture only those territories in Donbas region that pro-Russian rebels currently hold. This is what happened in 2008. Russia did invade pretty much the entire country of Georgia following Georgian aggression in South Ossetia and Abkhazia. As a retaliation, they were outside of Tbilisi, and then they pulled back just to those two enclaves.
So that's something to just keep in mind, that could happen again. That's very dangerous because the market will then have to start pricing in some odds of, I don't know, World War III, and then only realize later that Russians meant the initial salvo just to be an illustration of their might, and not an actual invasion. And then finally, limited incursion into Donbas, 50% probability. I don't understand why Putin would want to do that, but we can't really discount the probability of that happening as well.
- It's a very eloquent way of explaining the scenarios, Marko. So thank you for that. If you look at this, what I see also is that for basically-- the 50% of where something happens, you're talking about market corrections or something larger, depending on what actually happens. The other 50%, if it's a bluff-- you talk about buying opportunity for Russian assets. I'm curious for you, when you look at this, when are you going to start adjusting those probabilities? You talk about those first few weeks of February. When are you going to start to sharpen your pencil, go, OK, this has gone up and this has gone down?
- I think midway through the February, 10th to 20th, like February 15-- not to put an exact date on anything. One rule of sell-side is don't put an exact number or date, but I am going to do it, February 15. Look, at some point, it costs a lot of money to keep frontline troops ready. And at some point, it's not just about the cost, it's just why would you do it? Why would you keep frontline troops at an elevated level of battle readiness?
And so I do think the clock is running out, so February 15 or so, I think we start wondering whether this was all an elaborate bluff, an illustration of Russian power, but also an illustration of the divisions within the West which is now being articulated very well-- not by necessarily US and Western media, which isn't really emphasizing the breakdowns. But when the French president Macron talks to Russia independent of the US, when the president of Ukraine is basically panicking at why the Americans are panicking, those are things that really matter for the Russians.
And so I do think the longer this continues, the lower the probability of a major invasion or a major attack that will matter for global investors in Canada and the US, the lower that probability will go. So I think from mid-February onwards, we will have to start increasing the odds of a bluff, and I think the market will start repricing Russian assets in that situation. They've diverged from oil prices dramatically, and so there is an extraordinary off opportunity available for those willing to go high risk, high reward.
- I've only got about a minute, Marko, but let's just talk about commodities. You talked about Russian assets diverging from oil prices. Oil prices have been really moving up for a host of reasons, and this. What do you expect to happen with commodities? Because I know in the Crimea crisis also, we saw some big moves in gold and wheat, and we've seen actually most soft commodities start to come down.
- You know what? I would say that right now it's difficult for me to say how big is the geopolitical risk premium in oil prices. There may not be one, Kim. And the 2014 experience is instructive because you had both the Crimea situation and Islamic State took over Mosul, the second largest city in a major oil exporter, Iraq. And we all know, as Canadians, what happened to oil prices in 2014. They did not rally, right? They tanked.
And so I think that it's very dangerous to ascribe the current price of oil prices to what's going on here. In fact, I think that that would mean there's more upside if there is geopolitical conflict. But one of the things that I know from just quantitative research in this field is that oil prices tend to have very, very tenuous, and also fleeting response to geopolitical risks. They are worked for one or two days, or one or two weeks' worth of a bump, and then later that dissipates unless you are significantly impacting exporting or global supply in some way.
And I don't think that will happen here because I don't see the West imposing sanctions on a critical commodity that Russia produces at a time when the number one political issue in both Europe and the US is inflation and energy prices.