RSX: Panic Time?

| About: VanEck Vectors (RSX)

Summary

RSX dropped to fresh lows.

The ruble also drops to fresh lows against the dollar.

Will there be more downside for RSX?

RSX: Is Panic Around The Corner?

Now it's official: the Russian stock market (NYSE: RSX) is below 2014 lows. As my loyal readers know, I've long been bearish on RSX. I included my bearish thesis on RSX in my article "RSX: The bear thesis" back in June 2015. Since then, I've been updating my thesis. Also, I've been constantly challenged in the comments sections of my articles, as investors view Russia as "cheap". In this article, I would like to share my views on why my thesis was ultimately successful and what lies ahead for RSX.

Why the thesis played out

I don't dispute the fact that oil played a major role in RSX decline. When you bet on a play like RSX, which has 45.71% of its holdings placed in the energy sector, you have to get the oil direction right. So far RSX was not falling as fast as oil did, but it might soon be closing this gap.

I also would like to mention an interesting finding from reading the comments sections of my RSX articles. Those readers who, as I assumed, had direct knowledge of Russia (born there, lived there or worked there for a long time) were much more bearish than those evaluating RSX strictly from the quantitative point of view. I guess that similar skepticism on the country's general direction also helped those who were shorting Brazil.

Panic?

Let's get to the most interesting part after the brief discussion on what went in the right direction in the RSX bear thesis. Ideally, the best time to exit a successful position is during frenzy buying or selling. Some would certainly argue that this is also the best time to enter positions, but I prefer a more conservative approach for entering long trades or selling short.

RSX was declining gradually, the ruble was also showing relative strength thanks to Central Bank's actions in cutting the available ruble liquidity. However, everything comes at a price. The ruble-denominated price of oil continued to decline, and the Russian budget faced serious challenges if oil price did not rebound.

BofA Meriil Lynch has recently presented a table of their estimates of the USD/RUB exchange rate and budget deficit depending on the price of oil.

In the case of a $25 oil, the most realistic (in my view) is the case of 84 rubles per dollar and a 6.5% deficit. Short-term, this is not a catastrophe at all. At the end of 2015, Russia's international reserves stood at $368 billion, a significant amount if the Central Bank does not choose to burn it supporting the ruble. So far, the Central Bank was reluctant to use anything but REPO in its attempts to slow down the ruble's devaluation.

As I am writing this, USD/RUB is at 81.36 after reaching the historic high of 82.47. The official rhetoric is striking. The Central Bank's head Elvira Nabiulina told Bloomberg that the ruble was close to its fundamental levels and the Finance Minister Anton Siluanov stated that Central Bank's policy was smart. As I read through the press, other officials confirmed my view that there will be no extraordinary measures until the ruble falls like a rock (loses 10% of value in one day, perhaps).

The orderly decline of the ruble limited the downside potential for RSX. Yes, the currency is under serious pressure, but if we compare the ruble's movement on January 20, 2016 with the ruble's movement on December 16, 2014 we will find out that nothing close to panic happened on January 20, 2016. I must admit that the system has adapted to short-term shocks, and oil should drop even lower to induce real panic and capitulation.

Long-term threat

The real threat to Russia's economy and RSX's valuation is the ability of oil prices to stay close to current levels for a significant period of time. This will lead to shrinking reserves, the ultimate devaluation of the ruble and the capitulation of the stock market. When I say "significant" I mean 1 - 2 years.

Everyone willing to bet on RSX rebound now should take into account the fact that if oil freezes at current levels for some time, RSX will go down. The country's reserves look sufficient but they are not endless, and, at some point, Russia will be forced to devalue the ruble more to save reserves, which will automatically push RSX down.

However, I would not base a short case on such long-term threats, especially at current levels, where at least a technical rebound is a significant possibility. In my view, short sales are shorter-term by definition, and the lower RSX goes, the more I am inclined to get out of this position.

Bottom line

Those who are willing to bet on RSX for the long-term because it is "cheap" should seriously consider the existential threats that low oil poses to the Russian economy and Russian companies. Shorter-term, those betting on RSX decline should be aware of the short squeeze possibility, as oil fell too far too fast and there will be a lot of players waiting to catch a rebound in a beaten commodity.

In my view, the short thesis for RSX is still alive, but I don't think that one should sit through all the squeezes and rebounds in an attempt to exit the position at the very bottom. Bottoms are typically very pricey.

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.