Trade Notes: Stay Long Russia or Edge Towards the Door?

THE KREMLIN, MOSCOW. With President-Elect Dmit...
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Around 2007, Tim Rogers —  Valartis’ MC Russian Market Fund PM — said something very interesting about prospects in Russia.  He thought the days of making a killing just by picking under-appreciated Russian companies (i.e., pretty much any Russian company) were pretty much gone after the third level of privatizations.

Henceforth, the managers would have to make money the hard way:  by really working on picking the few remaining gems.  He’s no longer at Valartis, but it would be interesting to see how he would manage now.

Even Bill Browder — long after he stopped being a fan of Putin’s Russia — remained generally upbeat about cautious investments in Russia as a beta play on oil and EM.  Even his Hermitage Global fund has some Russia investments and that, considering his recent pronouncements on the country, speaks volumes.

No Russia investor can afford to avoid the noise around the country, especially with The Economist long beating the drum against Putin and Russia

After more than a decade with Vladimir Putin in charge, few can be sanguine about Russia’s direction. Its democracy is a sham. Strong growth may have raised living standards, but its dependence on oil and gas exports often makes its economy resemble that of the Soviet Union. Corruption has become so pervasive that it undermines even the functioning of the state. Above all, the rule of law is absent, as will be seen again on December 15th when a Russian judge is expected to sentence Mikhail Khodorkovsky to another term in prison.

But The Economist is not the only one, Denis MacShane also says that

Russia now ranks below Ukraine, Kazakhstan, and Nigeria in Transparency International’s listings of the most corrupt nations. Valery Zorkin, president of the Russian Constitutional Court, has admitted that his country is “something of a rogue state” in the international legal community. Anthony Brenton, Britain’s ambassador to Russia until 2008, notes with considerable understatement that “it would be much more comfortable” to live in a world that could trust Russia to respect the norms of international law and human rights. The WikiLeaks exposure of U.S. government views on the links between the Russian state and crime only bring into the open what every diplomat talks about privately.

Accepting all that, both managers made the same basic points for being long Russia:

  1. Russia is about oil, and if you’re long oil you have to have Russian exposure.  Not just to the oil/gas majors but also to the overall economy because of the boom caused by rising oil prices.
  2. Long oil means long EM, and with Russia part of the BRICs, you need to be long other sectors in the country too.
  3. The breakeven oil price for the Russian budget was at a ridiculously low USD 20-30/bbl range.  That too with a huge nest-egg in the stabilization fund

The first two points still remain valid, though Russia remains a laggard compared to the other BRIC components.  Now, Peter Aven, founding owner of Alfa Group is sounding a few more warnings in the FT, to him, the

Russian budget increasingly resembled the years before the collapse of the Soviet Union. Spending on social programmes had boosted state spending to 38 per cent of gross domestic product. The break-even oil price, at which the state can balance its budget with oil revenues, had climbed to more than $100 per barrel, compared with $20 to $30 per barrel before 2007.“Economically, we are returning to Soviet times again. When Gorbachev came to power, the country also had huge [hard currency] reserves and there was a low level of debt and a high oil price,” said Mr Aven, who is also president of Alfa-Bank, one of Russia’s largest private banks. “But within three to four years there was no money and a huge foreign debt.”

Capital outflows from Russia, considerably higher than in the summer, continued to mount. Central bank data show net private capital outflows reached $3.9bn in the week ended November 19, according to Goldman Sachs, compared with only $3bn a month in July and August. However, they eased to $2.2bn last week.

He said investors were shifting cash out because other emerging markets offered better returns.

“There are so many emerging economies where people believe there is huge potential for growth, and the problem is Russia is not regarded as one of them by investors,” he said. “That’s mainly because of the lack of competitive environment, corruption and the legal system which is not completely adequate. The level of investment is very low,” he said. The outlook was clouding further because state spending was stoking inflation which would reach 8 per cent this year, and could rise further next year, a pre-election year. The increasing vulnerability of the budget to the oil price was making tax rises for business in Russia almost a certainty, further worsening the outlook for economic growth.

Now, some of what he’s saying is very probably political maneuvering — there is scant difference between politics and big business anywhere, less so in Russia — but his words and the data he used give food for thought.  As Jim O’Neill mentioned at the Reuters Russia Summit, Russia always has the potential to surprise on the upside but the doubts remain.

For now, I remain long Russia and there remains a dangerous liking for such a wild, vibrant, shambolic, free-wheeling, and ultimately do-your-head-in frustrating country.  But I would look increasingly to cutting exposure to safe and “ant-fragile” levels.  Mostly to take profits out of a place that has done me so well, but also to take the money to more interesting EM locales, not to mention more stable yielding ones.

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