When I initially laid out my views on the Russian market (through the Market Vectors Russia ETF (NYSEARCA:RSX)) back in summer, I stated that the combination of weaker oil, sluggish economy and falling ruble will send RSX closer to the lows seen in December of 2014. Now, oil is trading at new lows, and RSX is finally below August lows. However, RSX is yet to touch the lows of December 2014.
When I wrote an article titled "RSX: My Prediction For 2016", I believed I won't write about RSX before the Russian Central Bank announces its interest rate decision on January 29. However, the situation is developing fast, as oil falls to lows that seemed unbelievable a couple of years ago, so I decided to present my views on RSX now.
So far, oil was everything that mattered
I must admit that my bearish view on oil was a major help for me to determine the direction of RSX, as the ruble was stronger than I expected, and the economic problems were probably priced in. With oil posting new lows almost every day, there's only one way for RSX - down.
Oil gets much negative press nowadays, so I won't beat the dead horse here. Since my last article on RSX was published, it lost 13%. At the same time, oil also lost 13%.
So, during the big Russian winter holidays, the market decided to just follow oil with the absence of other news. However, if we track the performance of RSX and oil back to the original bear thesis which was published on June 26, we will find out that the ETF lost 28% while oil lost almost half of its value.
Cold numbers tell us that RSX performed better than oil in that time period. In my view, this fact has two possible explanations; either RSX was really stronger than I expected or the market has yet to price in all the negativity, suggesting more upside.
The ruble remains relatively strong
Ruble remains stubbornly strong relative to oil. The more oil drops, the stronger (in comparison with oil) the ruble becomes. Of course, the ruble loses ground, but does it much slower than oil.
Earlier, I presented my explanation for this phenomenon. In my view, the Central Bank artificially decreased the amount of ruble liquidity available through REPO auctions to support the demand for ruble. You can find the data for ruble REPO auctions here.
However, it is possible that the demand for foreign currency fell significantly as imported goods and services became too expensive due to the devaluation of the ruble and this development supported the ruble.
The Central Bank balance of payments data supports this thesis, as imports of goods fell by 38% in the third quarter of 2015 compared to the third quarter of 2014. At the same time, imports of services declined by 31%. The other reason for the surprising strength of the ruble may be a simple fact that everyone who had money and wanted to buy dollars and euros already did that.
Russia lost many foreign investors since sanctions were imposed, and domestic players now have much more influence on the ruble exchange rate than in previous times. Obviously, those players can't get money out of nowhere for the purchase of foreign currency and the demand for the foreign currency diminishes.
All in all, the strength of the ruble pushed the ruble-denominated price of oil to 2,418 per barrel at the moment of writing this article. Compare this to 2,592 per barrel on December 18 and 3,512 per barrel on June 26.
Without any exaggeration, the current situation is catastrophic for the Russian budget, which aimed for around 3,150 rubles per barrel in 2016. It is already obvious that some cuts will be done, but you can't get away with just some cuts when the price of your main budget driver is almost 25% below your initial target. I have no crystal ball and I can't get into the heads of other people. The only thing I know is that the current situation with the budget and the exchange rate is unsustainable, and something will have to decrease, either the budget or the exchange rate.
I believe that the government will start with a budget cut and will hope for oil price upside before letting the exchange rate further down. Previously, the government showed what I believe was a sincere astonishment regarding oil price levels.
In other words, it looks like government officials just don't believe that oil can be that low. In this light, I think that the ruble exchange rate will stay relatively strong for a while and no actions to devalue the ruble will be taken unless oil stays at current levels for a longer time period.
Chinese developments are a longer-term problem
Most likely, you are well aware of the recent developments in the Chinese stock market. The country continues to negatively surprise investors. Like most, I don't believe that Chinese statistics truly reflect what is going on in the country, and this fact increases uncertainty and unnerves markets even more.
After a flurry of political events, Russia turned to China seeking more economic ties. Now with China seemingly getting weaker, Russia's economy may be hurt once again. However, I believe that any developments on this front will have long-term consequences rather than shorter-term effects, so the impact of negative Chinese news on RSX will probably be limited to China's influence on commodity prices.
RSX remains a short for those who are already in this position. However, current levels are clearly unacceptable for new positions, as the ETF proved its relative strength in the past and the situation with the Russian ruble is somewhat mysterious. Further weakness may be triggered by additional oil price downside and the correction of the ruble.
So far, there was no panic selling of RSX, and it showed an orderly decline. There is still a possibility that this might change and that we will see several days of severe liquidation. However, it looks like it would take sub-$30 oil for this scenario to become a reality.
Disclosure: I am/we are short RSX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.