Investing in Russia: Game Over?

Scan the international headlines over the past six months and it's hard to avoid noticing that Russia is sharply stepping up its anti-Western rhetoric. Investors in Russia's stock market are taking notice. A six-year bull run has seen the Russian RTS index rise from 38.53 in October 1998 to its peak of 1990.66 in mid-April -- a 52-fold increase. But even as U.S. and global indices break new highs, the dollar-denominated RTS index has fallen 9% since April 16. With the index down 4.8% so far this year, Russia is easily the worst-performing of the BRIC markets (Brazil, Russia, India and China).

Investing in Russia: The Court of Tsar Putin

Empowered by a rebounding economy and rising nationalist feeling, Vladimir Putin's chutzpah has reached unprecedented levels. Over a long-winded dinner at a fancy Moscow restaurant this weekend, he asserted that U.S. plans to deploy a missile-defense system in Europe will force Russia into a new arms race. In words eerily reminiscent of the cold war, Putin threatened that if the United States goes ahead with its missile-shield plan in Europe: "We will have to get new targets in Europe... Which weapons will be used... ballistic missiles, cruise missile or some completely new systems -- that's a technical matter."

In response to a question about whether he was a "dyed-in-the-wool democrat," -- as former German chancellor Gerhardt Schroeder once called him -- Putin responded without apparent irony: "I am an absolutely pure democrat. The real tragedy is that I am the only one. Elsewhere in the world, there just aren't any others...," he added sarcastically, as he cataloged human-rights issues in the United States and Germany. "Since Mahatma Gandhi died, there's just nobody left to talk to," joked the former KGB agent.

Although the Bush administration seems to be in denial, Russia has clearly started to play by its own rules. State-controlled Gazprom's veiled threats to cut off Europe's gas supplies make headlines monthly in the London press. Oil giants BP and Shell are under constant threat of having their licenses revoked. And what happened when tiny Estonia refused to pay obeisance to the Russian bear? It suffered a massive cyber attack from Russian computers. European Union and NATO membership offer no protection in the Internet wars.

The poisoning of Alexander Litvinenko in London this past fall with Polonium-210 confirmed that cloak and dagger style assassinations are not beyond the Kremlin's tactics. As a former KGB agent in London pointed out to me last month, with a Polonium pill costing $10 million, there is no doubt that Litvinenko's assassination received the Kremlin's tacit approval.

Investing in Russia: A Country Rotten To The Core?

The state of affairs in Russia is worse than grim -- at least that is the picture painted by Russian journalist Roman Shleinov at a lecture I attended yesterday in London.

Head of the investigative department of Novaya Gazeta, a leading opposition newspaper in Russia, Shleinov noted that corruption in Russia is so rampant that business is impossible without it. When Shleinov's newspaper -- whose backers include Mikhail Gorbachev -- publicly exposes cases of corruption, both Russian authorities and the public react with apathy. No public investigations are launched because no one’s hands are clean. And if a journalist gets too intrusive, they are murdered like Shleinov's colleague, Anna Politkovskaya. Here was the most shocking statistic of the night: Shleinov claims more than 2,000 journalists have been killed in Russia during the past decade under suspicious circumstances. That's more than the number of troops killed in the first two years of the Iraq war.

And unlike a cowboy Western, there are no guys with white hats. Exiled oligarchs such as Boris Berezovsky or jailed CEOs like Mikhail Khodorkovsky are “completely indistinguishable” from those sitting in the Kremlin, according to Shleinov. Nor can the “Western” cavalry come to the rescue. The only thing the Russians regard with more suspicion than their own corrupt officials is offers of Western help -- unanimously viewed as covers for Western plots to overthrow Russia. Chekhov and Dostoevsky offer a better insight into the Russian mindset than the latest Kremlin rhetoric.

Investing In Russia: Whither The Market?

Corruption notwithstanding, Russia's stock market has ranked at the very top of performance tables for much of the past six years. But this year is different. While global markets have been roaring ahead, Russia is the worst-performing major market in the world.

This can only be chalked up in part to the negative press surrounding Russia. Russian companies also have been unloading stock on the market as never before. About $24.8 billion of shares have been sold so far this year and up to $12.8 billion still is in the pipeline. The total figure last year was $21.8 billion, which itself was more than the total issued in the prior eight years. Valuations also have been aggressive, and shares have performed poorly in the after market. That situation has left a bad taste in investors' mouths.

The oil sector -- which makes up about 60% of the index -- has been weak as oil output has been stagnating. Oil giants such as Lukoil and Rosneft are spending money hand over foot trying to find oil in ever farther-flung areas of the country. Even gas monopoly OAO Gazprom is threatened by rising costs in future developments. Once a one-way bet, Gazprom's stock price is down 27% from its peak.

Overall, it's hard to avoid the feeling that the Russian market has its best days behind it. Russia's biggest investor -- Bill Browder of Hermitage Capital Management -- is diversifying out of Russia. This is just as U.S. retail investors now have the opportunity to get in through a new Russian ETF (RSX) launched in May. The smart money is exiting, just as the retail money is entering. That is perhaps the best indication that it's near “game over” for those hoping to make a mint in the Russian stock market.

Comments

[Alberto Col...:]

RSX may be a bad investment. I do not know. But at least some arguments made are either not true or look very suspicious. E.g.
1) 'The poisoning of Alexander Litvinenko in London ... with a Polonium pill costing $10 million ... no doubt ... received the Kremlin's tacit approval' --- this is pure speculation. To me this crime is a mistery. Litvinenko was unemployed or underemployed and badly needed money, knowbody knew about him before this tragedy.
2) 'Empowered by a rebounding economy and rising nationalist feeling, Vladimir Putin's chutzpah has reached unprecedented levels. Over a long-winded dinner at a fancy Moscow restaurant this weekend, he asserted ..." --- That was June 9-10 weekend and I read on many sites Putin was in St.Petersburg making speach on economic forum. My understanding is Putin (and people around him) do not go to restaurants, they have their privite retreats.

Most of this story looks fishy to me. However I do not have definite opinion about RSX.
E.g. mcdep.com places significant value on energy assets of OGZPY and LUKOY. But they go nowhere since May of last year.

2007 Jun 12 01:31 AM

[Alberto Col...:]

I fogot one more detail from Bloomberg. You can read it here
www.bloomberg.com/apps...;refer=home&si...

The article dated May 14, this year titled
Moscow Bankers Get $7 Million Payday, Double New York Average
By Elisa Martinuzzi and Todd Prince

It certainly does not make RSX a better investment but becase the original article looks lopsided to me I wanted to give a different view.

2007 Jun 12 02:39 AM

[pockyclips ...:]

The Russians have money, and have no need to kiss western butt, like in the '90s. I'm sure there's
payback involved in all this.

2007 Jun 14 03:03 PM