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Sometimes, you wish your predictions would never come true. This is one of them.

In early January, I wrote that one of the headwinds facing stock markets this year was the potential for war. I specifically referenced the increased Chinese pressure on Taiwan and the massive Russian troop build-up on Ukraine’s borders.

We all know what happened last week. But China’s position in these events has broader implications. On Feb. 4, three weeks before Russian President Vladimir Putin launched his massive invasion of Ukraine, he met with Chinese President Xi Jinping at the Beijing Olympics. A lengthy communiqué was issued at the end of the talks. Ignore it. Here’s what they really agreed on.

No action until the Games were over. It’s no surprise that the Russian hammer was dropped within hours of the torch being extinguished as Mr. Putin moved to recognize the breakaway states in Eastern Ukraine.

No condemnation. Even with Russian cruise missiles blasting Ukraine’s air bases and cities and live pictures of tanks and Russian soldiers in action, China refused to categorize the actions as an “invasion.” One guess as to how Russia would respond to a Chinese assault on Taiwan.

No sanctions. The United States, Canada, and Europe have imposed sanctions on Moscow. China won’t – at least not in any meaningful way. The result will be a strengthening of the economic ties between the two countries and a lessening of the pain the West’s sanctions will inflict against Russia.

The long-term geopolitical fallout looks ugly. Depending on what happens in Ukraine, Russia may feel emboldened to try the same tactics in other former Soviet states that have not joined NATO. China may see the West’s refusal to militarily defend Ukraine as an invitation to move on Taiwan. And the Russia-China axis will tighten as the two countries work in concert to weaken the United States.

This is the potential future. What does it mean for your investments?

In my January column, I said I expected a stock market correction in the first quarter, with a drop of between 10 and 15 per cent, followed by a rebound in the second half of the year.

We have experienced the correction phase, as least as far as the S&P 500, Dow Jones Industrial Average, and Nasdaq are concerned. The S&P/TSX Composite held up better, thanks to its heavy weightings in energy and materials. The S&P/TSX Capped Energy Index was up 24.6 per cent year-to-date as of Feb. 25 while the Capped Materials Index had gained 8.3 per cent. The Global Gold Index was ahead 8.8 per cent for 2022.

(North American markets rallied on Friday for no obvious reason beyond the fact that some traders perceived the fallout from Ukraine might induce the U.S. Federal Reserve Board to slow the pace of coming interest rate hikes.)

What stocks are benefiting? We have seen strong gains in potash producer Nutrien Ltd. (NTR-T), which will benefit as sanctions choke off exports from Russia and Belarus. The stock is up 18.7 per cent since it closed at $86.94 on Jan. 10. Mining giant Teck Resources Ltd. (TECK.B-T) is ahead 28.4 per cent since finishing 2021 at $36.43. Canadian Natural Resources Ltd. (CNQ-T) has gained 30 per cent since closing last year at $53.45.

Gold has been whipsawing, with big gains one day and pullbacks the next. Franco-Nevada Corp. (FNV-T) was trading at $163 on Jan. 27. The shares closed Friday at $186.94 for a gain of 14.7 per cent in a month.

Historically, major geopolitical events such as this have resulted in a market decline, but it is usually a blip and short-lived. The worst, according to LPL Research, was the Japanese attack on Pearl Harbor in 1941 that led to a 19.8 per cent market drawdown. It took 307 days to recover. On average, these geopolitical events result in a 4.8 per cent decline and a recovery period of just over 43 days.

However, we can’t view the Russian invasion in isolation. It comes at a time when overvalued markets were already showing instability, the effects of the pandemic are still causing supply chain disruptions, and inflation is running at levels not seen in decades. These conditions will continue to overhang the markets long after the Ukraine invasion fades into the background.

What should you do? I took a quick poll of my social media followers and found that 51.3 per cent of those who plan to take action are going to focus more on specific sectors of the market. A little more than a quarter of respondents intend to move to cash, while 20.5 per cent are going to buy gold.

Here’s what I suggest at this point:

  • Take some profits. It’s going to be a volatile year for stocks. If you have some big gains, take them off the table before they become small gains, or worse. The market rebound on Friday provides an excellent opportunity to implement this strategy.
  • Build your resource exposure. It’s been years since resource stocks have been a key part of a portfolio. But inflation and scarcity have pushed them to the forefront.
  • Own gold or gold stocks. I’ve always advised having a small position in gold (5 to 10 per cent of your portfolio) for times like this. Don’t be put off by the day-to-day price gyrations we’re seeing. The trend line is moving higher. Franco-Nevada is my top choice.
  • Don’t overreact. The Russian invasion was criminal and brutal. But unless Mr. Putin intends to launch a third world war by attacking a NATO member (very unlikely), the stock markets will absorb the shock and move on. Selling everything and moving to your underground bunker will achieve nothing except leaving your money fully exposed to the ravages of inflation.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe

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