March 25, 2014

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I recently wrote an article in which I highlighted some of the negative impacts that sanctions against Russia would have on some American investments. While I point out a couple of potential investment opportunities, I wanted to go deeper into a few ideas here.

Investors who are worried about the impact of sanctions on Russia should look for investments that will benefit from a scenario in which Russia is no longer exporting goods to the West. Russia’s primary exports are natural resources and raw materials, and so investors should therefore look for companies outside of Russia that produce the commodities that Russia exports to the West. If economic warfare escalates between Western nations and Russia, then the prices of the raw materials that Russia produces should rise, and this will benefit the Western companies that produce them.

The most obvious sector that investors should consider is oil and gas.  Russia is the top exporter of natural gas to Europe, and it is also the world’s largest oil producer. Therefore, investors should consider buying shares in companies that produce oil and gas outside of Russia. There are several of these, and the easiest way to access them is through an ETF. Investors should consider the SPDR S&P Oil and Gas Exploration and Production ETF (NYSEARCA:XOP ). This fund holds several oil and gas producers with minimal exposure to Russia. So far this year, the XOP has risen about 2 percent versus the Dow Jones, which has fallen about 2 percent.

Perhaps a better way to play oil and gas is to look at companies that focus on producing in Europe. One of the potential consequences of sanctions against Russia is that Russian oil and (especially) gas will not be exported to Europe. Investors expressed this fear when they sold off shares of Russian oil and gas producer Gazprom (OTCMKTS:OGZPY) when the crisis first erupted in the Ukraine given that the company owns a gas pipeline that transports Russian gas to Europe through the Ukraine. Given this, I think that companies that produce oil and gas in Europe should be beneficiaries of an escalation of economic sanctions between the West and Europe.

However, it is not enough to simply buy an oil or gas producer because it is headquartered in Europe. Companies such as BP (NYSE:BP ), Total SA (NYSE:TOT ), and Royal Dutch Shell  (NYSE:RDS.B ) are all headquartered in Europe, and in that sense they are European oil and gas companies. But you have to realize that these companies have global portfolios. If you want to buy shares in a company that supplies Europe with oil and gas that is produced in Europe, you have to look at individual companies’ portfolios. A good place to start is the Norwegian company Statoil (NYSE:STO ). Clearly, I’m not the first person to come up with this idea, as Statoil shares are up 15 percent already for the year. While I would wait for a pullback Statoil seems to be one of the top beneficiaries from tensions between the West and Russia. Furthermore, Statoil pays a hefty dividend, and it is as been outperforming its peers in the oil and gas space over the long run, which shows operational excellence and a devotion to its shareholders.

Investors should also look at palladium producers. While the palladium market is tiny Russia dominates the palladium market more so than any other market with control of over 40 percent of this metal’s supply. Palladium is essential in manufacturing catalytic converters, which significantly reduce the amount of pollutants emitted by automobiles. As the world “goes green,” the importance of such devices and the raw materials that go into making them is clear.

Investors looking for palladium investments have limited options.  There is one company  Stillwater Mining (NYSE:SWC ) that is a primary palladium producer in the West. The company owns the Stillwater palladium and platinum mine in Montana. The company’s shares are already up 24 percent for the year so you might want to wait for a pullback. Furthermore, there is some risk in holding these shares. The company’s past performance has been subpar as it was mismanaged. There was a scandal surrounding the former CEO’s large compensation package last year and this took its toll on earnings and investor sentiment. But this seems to be in the past, and going forward the company should offer leverage to the palladium price.

Investors who aren’t comfortable taking that sort of risk should consider the ETFS Physical Palladium Fund (NYSEARCA:PALL ), which tracks the price of palladium. However, this fund is somewhat illiquid. The best option, in my opinion, is to simply buy palladium coins and bars. Canada makes a palladium Maple Leaf, and Credit Suisse makes a bar. These items can be purchased at your local coin shop or through an online bullion dealer.

Finally, investors should consider shares in defense contractors. These shares generally trade at a discount to the S&P 500 given that America’s defense budget has been shrinking. But if economic tensions between the West and Russia heat up then there is a greater chance for a physical war. Even if it never amounts to anything the possibility itself should be sufficient to drive these stocks higher. While there is an ETF that holds a basket of these stocks the Powershares Aerospace and Defense ETF (NYSEARCA:PPA ) I wouldn’t buy this fund given that there is very little liquidity.

Investors should consider designing their own basket from the larger defense contractors. Two companies that stand out as good value plays that will benefit are General Dynamics (NYSE:GD ) and Northrop Grumman Corp. (NYSE:NOC ). These companies trade with P/E ratios of around 15-times earnings, they pay dividends greater than 2 percent, and they have been aggressively buying back their own shares. Any hint that their earnings could rise due to increased defense spending will send their shares higher.

Ultimately, no one wants a conflict between the West and Russia, but governments on both sides are taking steps in that direction. Therefore, the investments I highlight here have a good chance of being winners.

Disclosure: Ben owns palladium coins.

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