Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined today by my friend and colleague, Kim Catechis. Kim, share a little bit of your background.
You're a global strategist. You see the world from a very different lens than I think a lot of our other guests. And I know you and I wanted to delve into geopolitics and some of the implications, but maybe just to provide our audience a little bit of your background and how you see the world.
Kim:
Tony, thank you, first of all, for inviting me. I'm seriously honored to be on this great podcast. I'm a fan. I follow it religiously.
So background, I started out in the investment world after a stint in manufacturing industry in the UK and I became a trainee investment manager, UK European equities to start with. Then a few years as an emerging market specialist and then after that, global equities. And my role, this current role I've been in for almost 10 years now is as an investment strategist.
So basically what that means is I can get involved in a bit deeper research on areas of interest to our clients and I get to speak to really well-informed, intelligent people on a basis, which is an absolute privilege.
Tony:
I think you're being humble. I think one of the things that you bring to the institute that we certainly value is a great lens from geopolitical issues happening all over the world. And what we wanted to delve into today was some of the conflicts in the Middle East and in particular where we are today.
And then as we go through that, we'll talk a little bit about what the investment implications are. But maybe if you can, frame where we are as this conflict in the Middle East has gone on for quite some time now, but it seems like we're reaching a point of time where we've got an agreement in place.
Kim:
So the first thing I guess I would say is that to make it more sensible, what I would say is start off with a perspective of the region. This is a complex region and I know that word's been used a lot. In this case, I think it's a really accurate description.
The Middle East has a number of fishers and splits in it. These are religious. They're a sectarian within the same religion. They are political. They are social – ethnic in some cases. And then of course, remember that like most of the world's map, the lines were not drawn by the people on the ground. They were drawn by imperial powers, you know, 2-300 years ago or whatever. And that creates problems of its own.
Now, you're in a region now where the situation at the moment is you've got a group of countries that are uncomfortable, frankly, with their neighbors. They're uncomfortable with the neighbors, but unlike in most families, you know, if that were a family, you'd be saying, well, let's try and get a house across town, even if it's smaller. Let's move.
Well, in this case, that's not an option. So on the one hand, you've got a group of Arab countries. You've got a Persian country predominantly, which is Iran. That's a very different culture. And then you've got Israel. And for the Arab countries, their whole economies depend on their ability to export hydrocarbons predominantly, a lot of other products, you know, our site production come out of their production hydrocarbons.
But basically they're dependent on being able to export them. They've viewed over the decades, Israel and Iran as two relatively difficult neighbors. And they've managed to come to some kind of accommodation whereby the two of them kind of cancel each other out. And as a result, everybody else gets on with their life more or less.
Today's situation is one where that is not possible anymore. We've had a 12-day war a year ago. We've had almost three in a bit months war just now this year. And it's the old story about Pandora's box. The box has been opened and all these worms and things are out and it's impossible to get them back in again.
For the Gulf countries, they literally have taken big hits to their economies. For a country like Qatar, which is almost 80% dependent on export of liquid natural gas, the liquefied natural gas LNG, that's a massive hit. The IMF is suggesting they could be 8 to 10% hit to their GDP this year. I mean, that's really bad news for them. For others, it's varying degrees.
Where we are is, I guess, a place where there's an uncomfortable truce. I mean, this agreement looks like it's going to be a truce. We hear talk of 60 days. We've had that before.
Ultimately, it doesn't seem possible to imagine a world where all of these frictions are taken out. So the frictions remain. And because those frictions remain, the fissures that I talked about, the splits in the region are likely to remain as well.
So what's happening in the short term is you're seeing all these countries that have come through physical damage to their infrastructure, to their exporting infrastructure, the production infrastructure, et cetera, reinvest and fix that, you know, all those things. But they're also reinvesting in defense. They now know drones are extremely difficult to stop, missiles are expensive to stop, and they need to be prepared for the next time.
Everyone around the world outside the region is looking at this and saying, well, we always knew that Iran could try to block Hormuz. And sure enough, that's what they did. So the fact that they've done it once means that it's possible that they do it again.
Tony:
Let's slow down and break down some of those things a little bit. So I think you're kind of leaving us where we really should start, which is the Straight of Hermuz has been closed. Oil prices have skyrocketed. And even though there is a truce in place, and I like the truce because I think the agreement essentially says it's an agreement to continue negotiating and they're talking about 60 days. It could be extended beyond that.
So given this truce and given the fact that at least in theory, this Straight of Hermuz is supposed to open, at least here in the U.S., and I suspect you're hearing different sort of things maybe from your vantage point, but at least here they're talking about, well, that means oil prices should go down. But I think one of the things you've shared in multiple calls that we've had is there's still a bottleneck of getting what's in the Straight now out and then ultimately getting manufacturing back to where it was. So how should we think about oil? Does it go back to its previous level? Or is there going to be an extended delay to get there?
Kim:
The situation before this started in the 27th February is that the world basically produced around about 108 million barrels a day and consumed 104. So that gave you a price of bread to round about 60, $65 thereabouts. Today, you've probably lost a great number of barrels over a number of days, you know, the three months that we haven't had even export of oil.
It's not as simple as saying, oh, 20 million barrels a day, you know, gone, because there have been drips and drabs of oil coming out. The Saudis, for example, have been able to export between 5 and 7 million barrels a day by piping their oil to the west coast, the Red Sea. The one planned cushion, if you like, for the world was the agreement early in March to release in a coordinated fashion strategic petroleum reserves. And that has helped soak up some of the potential pressure. So the oil prices that you see on your Bloomberg screen did not go up to $200. I'll come back to this point in a sec.
The other big advantage that we've had, and frankly, I don't think too many people expected this, and certainly I didn't, was that we had an unexpected bonus in the sense that China bought around about one and a half on average, 1.6, 1.7 million barrels per day less this year than they did in 2025. Why did they do that? Partly because, you know, they've already got big reserves on a national scale, but also big commercial reserves, and partly because they just use other sources. You know, they've got their own production and they've got other imports from other places, Central Asia pipeline, for example.
So what the two things combined is the release of strategic petroleum reserves and the less lower buying from China has helped stop the financial price that we see in our screens rocket. Now, I have to come back to this, as I said, because in actual fact, in the real world, we did get prices that were ridiculously high.
So for example, what we found was Singapore, which is, you know, a main route along a main stopping point along that trajectory of taking oil out of the Gulf and into Asian economies. Singapore experienced such a shortage of jet fuel that at one point you had an oil price of about $110 on our screens and jet fuel was 230. You also had diesel about $180.
Now, in many ways, for these economies in Asia, that was more damaging than an oil price of $200, a crude oil price of $100 in the short term. Why? Because diesel, for example, in the same way as in the US or in Europe, farmers require diesel. They need it for everything. It's not just the tractors, you know. And the problem you've got is that if farmers end up having to pay higher prices, then sooner or later that trickles through into food pricing.
So that was the big fear in most of these countries. So I guess we got lucky on that front.
Tony:
And I'd love to pick up on that because I think you're right that the headline is oil, but a lot of times it's the other sort of issues. And I know, again, this is something you've kind of helped me think through. It's the fertilizer, the helium, it's the impact on the farmers.
Ultimately, you know, does this become inflationary? Because somebody's going to have to bear the cost, the higher cost of goods and service. So help us kind of think what is the trickle effect on everything that's going on there?
Kim:
Let's stick with farmers, for example, because that's something everybody probably is a generation away from. Certainly in my family, we're a generation away from farming. But what I'd say is fertilizer is a byproduct of processing oil, fertilizer is necessary to grow crops, and it's an international price. It's a global price. So even though there was no shortage of fertilizers in the Midwest of the US in early March this year, prices went up because they're global prices. So you found that farmers in the Midwest were probably getting asked to pay 30, 40% more for certain fertilizers.
Now, if you're a farmer and you're seeing your fertilizer price go up, and obviously you probably have bought some already, but you may not have bought everything that you require for the season. You've no idea this is coming. You might decide to use less fertilizer.
And that's not a big problem, really. I mean, if it's a fertilizer that's based on, in a nitrogen, for example, that is harder to deal with because by nature, then nitrogen will evaporate in from one year to the other. Whereas you could argue there's some fertilizer left in the ground from the previous season.
But either way, you should expect yields to be lower in September, October when you start to collect those crops. And for the world as a whole, it's not yet a problem because you've got production from the Southern Hemisphere working on different seasons. So Brazil, Argentina, et cetera, there'll be big producers of crops as well.
That's one way it feeds into the price of food. The other way it feeds in is as again, through the diesel prices, or one example, one offshoot that one kind of unexpected perhaps or less obvious impact was you might say to start with, okay, so there's less oil coming out of the Gulf countries. Who else exports oil that we can buy oil from?
And you might think of Brazil, they're actually on an upward trend in terms of exporting oil. But the government of Brazil looked at this and said, well, actually, we're worried because we don't have enough refining capacity domestically to produce enough diesel for our farmers. So what we're going to do is we're going to put a tax on exporting of diesel.
And we're going to put a tax on export of oil. It's not just opportunistically trying to make money for the government. It's actually trying to squeeze the flow of exports because you're worried about your own market.
So for a time, that was another complicating factor around the world.
Tony:
Let me try to maybe tie some of this together as we think about kind of the investment implications and private markets in particular. I think one of the things that the conflict has certainly pointed out to all of us is we need to rethink our supply chains, right? We started to rethink our supply chains with COVID.
And now with everything going on, we definitely need to rethink it, which ties into a couple of the macro themes that we've been thinking about here, which is this de-globalization, you need to secure your supply chains, make sure you can get your goods and services. The other sort of impact is we're starting to realize much of the world is dependent on the Straight of Hormuz and the oil, the fertilizer, the helium, all the things that come out of there. So we and other parts of the world need to think about how then do we make sure that we don't have this disruption in the future.
So again, I think building manufacturing here in America, which is certainly been a theme we've been talking about, we think it kind of manifests itself in real estate, where we're going to have to build more manufacturing facilities, more industrial parks. We're going to see more infrastructure build out just as more things will be built here, probably more of an energy transformation, so we can actually build things here.
The U.S. several years ago moved in much more of an energy independent sort of fashion, which I think helped us a little bit. But I suspect that other parts of the world are going to have to think about this as well. I wanted to maybe, again, trying to avoid getting too political in nature, but maybe if you could, Kim, you see the world very differently than I think a lot of my colleagues do here in the U.S. in the sense that you see how the rest of the world community reacts to the United States’ role in executing this war. Who are the winners here? And ultimately, who are the losers?
And when I say losers, does that mean our relationship with our former allies? Who are the winners and the losers from your vantage point?
Kim:
I think nobody really wins outright because everybody got hurt. You could argue that on a political level, Iran's power structure was set up deliberately like a lot of these autocratic countries with competing power bases that don't really trust each other. So it kind of minimized the opportunity of a coup.
So you had the Revolutionary Guard, you had the plain vanilla normal army, and you had the internal security guys. And over them was the Ayatollah. An unintended consequence of this war has been that it seems that the Revolutionary Guard basically wiped the floor of everybody else. So they are now in charge.
Now, on one level, you could say that's a good thing for everybody else, because we know what we're dealing with. On the other side, it's not great because these are the guys that are most extreme, right? And they're now in a weakened position. Let's make no, I don't want to overgloss this. They are weaker. They've been hammered physically, but they're in charge. An internal dissent is crushed. So for them, that's a good outcome. And they're getting to sit at the table with the U.S. and argue about whether they get money for opening the Hermuz, et cetera, et cetera. So for them, that's a win.
Russia briefly was a winner because they got their sanctions lifted and the oil prices being high that helps finance their war in Ukraine and in Africa and whatever. So that was a good thing for them for a while that it was slightly hampered because Ukraine proved very adept at hitting export installations, which meant that they weren't able to make hay as they could have done. They still made probably a couple of billion dollars more than they would have done otherwise, for the period of time that they had those sanctions lifted.
China, you could say won out of this. They won on the different levels. The PLA won because they got a ringside seat at watching the U.S. deploy really sophisticated and awe-inspiring war technology. They also saw that there's a parallel here with Russia on paper, a crushing advantage over Ukraine. And yet, here we are four a bit years later. This war in Ukraine has now lasted longer than World War I. And yet, the Ukrainians are still standing.
There's a parallel there that the Chinese are learning that maybe there's a limit to U.S. air power. You can't actually change facts on the ground just by using air power, awe-inspiring as it is. They also won because they were able to use some soft power by saying to poorer countries who also have a vote in the United Nations, by the way, you know, this is another thing we forget about. You go to the poor country and say to them, “Hey, listen, guys, I know you can't afford these new prices for oil and gas. We can supply you some.” It's like the COVID diplomacy thing. Remember, we'll give you free vaccines, you know, or free equipment for your medics, et cetera. So there's a soft war gain for them as well.
And then the third part of it for them is they can go out present themselves and saying, “Hey, we are a stable commercial partner. So you can do business with us. And we won't be creating volatility.” Those are some grounds where you could say they won. I actually kind of think that for the U.S. and for Europe, in the future, we're going to look at this and say, that was rough. But we actually got ourselves in a better position as a result of it. Quite often, you get something wrong and you learn from it. For the Gulf countries, without a doubt, they learned that they have to really step up their investment in defense and in alternative ways of getting their exports to the world.
And I think one of the big things we're going to notice, you know, in the future, we're going to turn around and look at this and say, that was the point at which Hormuz was peak strategically important, in the future will not be. Why? Because every one of these countries is going to spend whatever is necessary to build a pipeline out of the region that avoids Hormuz.
One example, I can give you a really up to date one. I was going through some research this morning. Japan was the most exposed Asian country to Gulf oil exports. Up to the 27th of February this year, Japan got 95% of its oil from the Gulf. And all of a sudden that closed off. At the end of May, they were importing something like 60% from the Gulf.
Tony:
Big difference.
Kim:
And by the end of July, they reckon they're going to be at 0%. So one of the learnings, if you're Japan, you look at this and you say, I will never again depend on that region for 95% of my oil. I'm going to have to diversify. South Korea has done the same. They've gone down from 70% to 48%.
And where do they get it from? Well, they get it from Azerbaijan, they get it from the U.S. That's another winner out of this. You know, another side of the U.S. is winning. They get it from African countries like Nigeria and all these places in the end, they're going to do quite well out of it.
Tony:
So that kind of leads me to the next question, which is what are the lessons learned from as you talked about, we need to think about supply chains and make sure that we get oil in other parts of the world. And maybe you have different trade partners.
I wonder militarily, though, whether there's lessons learned – the next conflict that everyone talks about is Taiwan. I'm sure China is watching how we execute this war. Are there lessons to be learned for China and Taiwan or maybe other areas of interest like Cuba, which is another area that the U.S. has taken a certain amount of aggression with?
Kim:
I've done a lot of research on this from the perspective of an investor, right? Because at the end of the day, our clients want to know, how is this going to impact their investment returns, the rest allocation, et cetera? As you know, Tony, you've seen it, we've worked out, thanks to our, we've got this big country risk framework that is basically a massive data warehouse. We can work out which countries are the most exposed. And the most exposed country in this particular situation is Pakistan.
And that's, of course, no coincidence that Pakistan has been taking such a strong role at trying to get a resolution here. 90% of their gas imports come from the region. They're really situated right next door. They have a land border. They've got every incentive to try and get this sorted out.
So the learnings, and I'll go through learnings first. So the learnings are we, as in the west, I think, have been brought up to think dismissively about the agency that second-tier nations have, generally, because we're used to a world where the U.S. is the superpower, especially since the end of the Cold War. And, you know, the Europeans kind of ride along the coattails and no one else really gets to say very much.
In this particular situation, we have seen the agency displayed by Pakistan, by Turkey, by Saudi. All of a sudden that is changing the power map of the region. And one of the learnings is that in defense terms, you're not going to see, I don't think we're going to see these Gulf countries give up on the U.S. They're obviously disappointed, but they're not going to give up on the U.S. What they're going to do is they're going to diversify their portfolio of defense relationships. And one of the big winners is Pakistan, because they now have a mutual defense pact with Saudi. And that's obviously very good for Saudi because Pakistan has nuclear weapons. It's probably one of the reasons that Saudi wasn't so badly hit in this particular conflict. You're going to see a different tack taken by the United Arab Emirates. They're doubling down on the U.S. and Israel relationship. The others are not so keen.
The other learning, I guess, bringing it back to investment is that that region, those countries had cheap energy and that made them good places to consider for placing data centers. Well, at least three or four of those data centers got hit in this latest conflict. So what I would expect is to see a rethink of that and a kind of hardening of defense of their critical infrastructure like energy. And the other learning, of course, is that the fact that a data center is going to be attacked tells you that the traditional way we thought about a war is gone now. All sorts of, you can bring your enemy to their knees by knocking out their electricity grid. If you can destroy data, you know, just data centers, whatever that makes them a target as another angle.
Another learning, I think that we should all bear in mind is, you know, what we've already been on the long educational course. And that is the weaponization of supply chains. Now, supply chains used to be, according to the textbooks I grew up with and probably you grew up with Tony, the number one priority was to optimize costs, quality control and delivery. And the best industry to use as an example would be the automobile industry, because those guys, the assembly plants for cars would typically receive whatever they would have no inventory, because the component parts would arrive something like 45 minutes before they're needed on the actual production line.
So if you're the finance director of a company like that, you have practically zero working capital requirements, because everybody else is looking after that for you. And the new learning is that because you're having to, partly because of reshoring, partly because of tariffs, partly because of just unavailability of components, you're forced to, and this is something I came back from the COVID days, you're forced to keep inventory. And if you're keeping inventory, that means you can't be as efficient in your use of your capital, right?
You have to expend some working capital. For the private markets, I guess, that's a positive because it means more requirement for logistics centers and warehouses and all this kind of thing. And that is something that I think we're only just scratching the surface of, because just think about the number of different business sectors that have not yet built there or locked up, maybe they're renting, not them building, you know, their own capacity for storage of components, because ultimately you don't want to be in a place where you're selling a $1 million product and you're missing a $5 part. So you can't get your $1 million. I mean, I'm using silly numbers, but you know what I mean?
Tony:
A very important point. Is there a playbook that has been created for the next conflict like a China and Taiwan?
Kim:
I'm sure there are. I mean, I know for a fact, I mean, you can look it up yourself. There's a lot of good think tanks with very well-resourced, capable and knowledgeable people who've been studying this, you know, as the day job. There are parallels with Taiwan and I think the main parallel is on blockades, not so much on amphibious landings.
I have friends in the British military who tell me that it's probably unlikely that we ever see another large-scale amphibious landing. The last one was the Korean War. Taiwan doesn’t lend itself to this for another couple of reasons. One of them is that the topography is different, the geography.
So Normandy beaches are long, extended, and you get relatively shallow so you can bring your troops in quite close. The west coast of Taiwan is very mountainous and rocky and even on the east coast there's not that many places. But as we've learned, you can do a lot of damage just by blockading, naval blockades and how these work is going to be, you know, what other things they're all focusing on, I guess, is going to be the use of drones.
Underwater drones, sea drones, their surface drones, as well as aerial drones that we're used to thinking about. One great example here is how the Ukraine that basically didn't have, Ukraine didn't have a navy. They managed to not only sink a good 30-40% of the Russian Black Sea fleet, but, you know, the flagship went down quite early as well. And they've now been able to force the Russian navy way over to the other coast of the Black Sea because they can't be at their normal naval base. They're within range of these long-range drones.
Tony:
Kim, thank you so much. I could go on. I always enjoy listening to you when your ability to kind of articulate how all these moving parts kind of fit together, I think, is so helpful for our audience.
I think from an investment perspective, and I don't know that from a private markets perspective, I'm not sure anything has changed dramatically, other than it does reinforce some of the themes that we've been talking about, which is this re-shoring, bringing manufacturing back to America. You mentioned data centers, something we've been talking about a lot. We think data centers, the growth of them here in the U.S. is a great infrastructure play.
We definitely believe in the merits of diversification because we will continue to have shocks all over the world. This is not a new phenomena. I suspect we'll have more and more shocks going forward, so diversification matters.
Diversification across private equity, of course, manifests itself in secondaries or specifically looking at asset classes that have low to negative correlation, like real estate and real estate debt. So again, I think there's a lot of implications as we think about using private markets to build portfolios, but I really enjoyed listening to your perspective on the world as you see it, and you've articulated where we are. Ultimately, I think some of the lessons learned from this conflict in the Middle East.
Kim, I thank you.
Kim:
Tony, thank you very much. Really enjoyed it. Thank you.
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