Everyone fears Russia as the great bogeyman of the East.
It’s a primordial dread dating back to Ivan the Terrible. And it lives on with President Putin the Shirtless.
Let’s not kid ourselves — much of it is justified. Great hoards sweeping in from the East have plundered Europe for millennia. Attacks into Russia from the likes of Napoleon, Hitler, and Charles XII of Sweden have ended empires.
No one can forget Nikita Khrushchev banging his shoe at the UN and screaming, “We will bury you!”
Putin is a strong Russian leader of the type the peasants love. He wants to be a leading player in global geopolitics, and his support at home has never been higher.
He has played the nationalist card over the last few years by annexing Crimea, causing trouble in Ukraine, supporting Assad in Syria, and selling Iran anti-aircraft missiles.
This has redirected the populous hate from the biggest Russian recession since 1998 — a recession brought on by oil oversupply and Western sanctions.
Going Up
Despite all of this, it may surprise you that the Russian stock market was the best performing of the major markets last year and is in the lead again this year.
Going back to May last year, the market is down just 10% from its former pre-crisis highs. In 2015, the Russian exchange-traded fund (RSX) is up 35.8%. Meanwhile, China is up 24.5%, and the MSCI Emerging Markets Index is up just 9.8%.
If oil continues to trade above $50, then Russia will make money and will have recovered from the economic sanctions in less than two years. If these sanctions are removed and oil holds in the mid-$60s — which is the view of Energy and Capital — the Russian market will fly.
Thus, John Templeton’s maxim that you buy at the point of the greatest fear.
Investors in emerging markets are quite familiar with this value line of thinking. While most lay people will talk about how things fall apart, after they have already fallen, successful investors will look ahead and imagine the positives. To paraphrase Warren Buffett, be bold while others are fearful.
This is what I like to call “The Fear Arbitrage.”
Right now, Russian assets are clearly distressed, and positive events are on the wind.
Ukraine
Secretary of State John Kerry was in Russia this week talking to his counterpart about securing the cease-fire in Ukraine.
Contrary to what you might read in the Western media, Putin has little desire or money to take over Ukraine and is already struggling with millions of refugees. He has accomplished what he wanted, which was a land bridge to Crimea, as well as access to its vast offshore oil reserves.
He has given a message to Obama, as well as his political enemies at home.
The Voice of America backs this up:
Fears of a new surge in violence are overblown because the Kremlin’s mood is shifting to accommodation, says the director of the Carnegie Moscow Center, Dmitri Trenin.
“No major offensive is possible,” says Trenin, “absent a Russian nod or Russian acquiescence. And, this I don’t think will be given under the present circumstances.”
Political analysts say visits like Secretary Kerry’s are welcomed in Russia because, despite the Kremlin’s actions in Ukraine, Putin wants to portray his government as a peacemaker open to dialogue.
He also wants a return to the Soviet-era treatment of Russia, when it was respected as an equivalent but alternative voice to the United States in global affairs.
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The Ruble Rebound
After the sanctions were imposed, the ruble fell some 40% against the dollar. Russia became a low-cost producer, and there was a large jump in exports. Hardwood, palladium, and other commodities flew out of the country.
Exports of caustic soda, which is used in PVC pipes, climbed 43% in the first quarter alone.
More recently, the Russian currency has bounced back off the bottom. The central bank is now buying $100 million to $200 million in foreign currency daily.
The purchases are meant to regain the $88 billion lost buying rubles over the winter. Russia still has plenty of reserves left over from the days when oil was above $100. Foreign reserves stand at $385.5 billion.
According to Bloomberg:
Policy makers, who shifted to a free-floating exchange rate in November, are resuming currency purchases after a rally that turned the ruble into this year’s best performer against the dollar among more than 170 currencies tracked.
The ruble has strengthened 21 percent against the dollar this year after losing almost half of its value in 2014. It weakened as much as 2.8 percent, the most this month, before trading 1.2 percent weaker at 49.8640 against the dollar by 10:08 a.m. in Moscow.
In other words, the currency has stabilized. Reserves are growing, and debt-to-GDP is low at 14%. The Russian economy has weathered the storm.
And there is incredible value still. Most of the run in Russian equities have been a direct result of the currency appreciation. There has been little in the way of equity prices going up in terms of value ratios. The RSX ETF still carries a price-to-earning ratio of 6 and is trading at a 30% discount to book value.
Value, Value, Value
As I said, the debt-to-GDP ratio in Russia is low. There is almost no leverage in the economy — not on the household side, in government, or even in most corporations.
This contrasts sharply to the U.S., which will have real difficulty paying off its $60 trillion in debt (household, government, and corporate) in the event of the next banking crisis.
This means Russia can survive hits and bounce back.
Despite upheaval on the Ukraine-Russia border, the resulting sanctions, and weak energy prices, Russia is an investor favorite.
This year’s CFA Institute survey of global asset managers put Russia at the fourth market investors expect will bring them the biggest returns this year. So far, it’s the No. 1 market for returns this year.
I recommended my first Russian investments in 1996. More recently, I told you to buy Gazprom just this past March.
If you had acted on that recommendation, you would be up 37% in just a few months.
My Crisis and Opportunity readers also profited 26% on a short-term trade in a Russian Internet company.
Right now, I’m putting together a special report on Russian opportunities that will destroy the U.S. market in terms of returns. Please keep an eye out — I’d hate for you to miss out again.
Lock and load,
Christian DeHaemer
Check us out on YouTube!Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
