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Individual investor with financial experience and technical background. Focused on preserving wealth and growing capital through long-term strategic value investments. Invest in developed and emerging markets, in stocks and currencies.
  • Russian Bear Or Russian Roulette? 0 comments
    Apr 30, 2013 3:43 PM | about stocks: RUSS, RUSL, RSX

    With a 14.5% drop from the end of the January 2013 high to the mid-April low the Russian stock market (MICEX index) is still trying to find the bottom. However, there are some fundamental drivers that add downward pressure on the market and may result in further decline.

    In this note I would like to provide some information that I hope will help you to make your own decision about further market direction and attractiveness of participating in this move through Direxion Daily Russia Bull 3X Shares (NYSEARCA:RUSL) or Direxion Daily Russia Bear 3X Shares (NYSEARCA:RUSS) ETFs by Direxion.

    Current Russian economy fundamentals:

    • Oil and gas prices decline: the Russian economy strongly depends on oil prices. Further oil price declines due to the global economic slowdown can severely damage the economy and stock market.
    • Capital outflow: the Russian stock market is driven by external liquidity. The economy has been experiencing continuing capital outflow of $80bn in 2011, $57bn in 2012, and $14-16bn in Jan-Feb of 2013 alone. It is estimated that in 2013 capital outflow can reach between $50bn and $80bn.
    • Decreased export: exports for many goods and natural resources, including metals and steel, chemicals, and paper are decreasing.
    • Low internal demand: existing internal demand does not substitute declining external demand for exported natural resources.
    • Low economic growth: after the recent manufacturing production drop the government reviewed and lowered economic growth forecasts for 2013 to 2.4% from 3.6%.
    • High inflation and high nominal interest rate: the real interest rate is close to zero. Further nominal interest rate decrease can lead to increased capital outflow.
    • Unemployment and capacity utilization: the unemployment rate of 5.3% is low and is accompanied with high capacity utilization. That means that most likely the economic growth is limited by supply, not demand.
    • Population aging: decline of work force due to the aging of the Russian population contributes to economic slowdown.
    • Government instability: With more publicity of high-level official corruption and the slowdown in the economy, more officials are resigning or getting fired. With continued fight for diminishing capital and power among the Russian elite, government shakeup is possible.
    • Russian Ruble depreciation:
      • The Budget: the current budget surplus is supported by oil and gas revenues. So possible oil and gas price decline will increase pressure on the Ruble.
      • Rates lowering: the Central bank policy of lowering long-term interest rates will add additional pressure on the Ruble.
      • Currency wars: the government can decide to weaken the Ruble to support the economy. In the case of further Ruble depreciation, many companies and individuals will convert Rubles into other currencies, mostly USD and EUR, accelerating capital outflow.
    • Negative investing climate due to Cyprus situation: many financial transactions in the stock market as well as trade transactions for real sector companies were conducted through Cyprus, not mentioning money laundering transactions used by corrupt government officials to conceal bribes received. About 20% of all official foreign direct investments into Russia were from Cyprus.
    • No dividend stock rally: with upcoming dividend payments in April/May, dividend-paying stocks have no sign of rallying. In addition, traditionally the market corrects in April/May after dividends cut off.
    • Management quality: expected privatization of several government-controlled companies perhaps will not attract investors due to deteriorating management quality in these company and misalignment of the interest of the management and equity holders. The corruption at government-controlled companies like Gazprom or Rostelekom is well-known and casts doubt on quick profitability improvements in such companies.
    • Financial reporting quality: Even though many big Russian companies in addition to financial reports based on Russian GAAP also publish financial reports based on FIRS or US GAAP, these reports typically become available with some delays. In addition, some companies like Gazprom in general publish financials with significant delays. For example, when if Alcoa reports annual results in February, Gazprom reports its annual results only in May/June.

    To sum up, the Russian stock market is driven mostly by oil prices and capital inflows. The ongoing correction in commodities and growth of the US and Japanese stock markets, as well as strong moves in the FX markets attracts investors and their capital, leaving prospects for the Russian stock market weak.

    RUSS and RUSL:

    3x Leverage ETFs RUSL and RUSS provide opportunity for investors to benefit from growth or decline of the Russian stock market. However, there are some significant risks:

    • Leverage: these are 3x leveraged ETFs and in case the market goes against your position your pain will be significant.
    • No guarantees: as Direxion states, "The Daily Russia Bear 3x Shares seeks daily investment results, before fees and expenses, of 300% of the inverse (or opposite) of the performance of the Market Vectors Russia Index. There is no guarantee the fund will meet its stated investment objective."
    • Only intraday movement counts: In case the market opens with a gap, you may not benefit from it: "This leveraged ETF seeks a return that is -300% the return of its benchmark index for a single day. The fund should not be expected to provide three times the return of the benchmark's cumulative return for periods greater than a day."
    • Underlying index: Both RUSL and RUSS use as its benchmark Market Vectors Russia ETF (NYSEARCA:RSX) and not MICEX index itself. Market Vectors Russia ETF consists of top Russian stocks with top positions in SBER, LUKH, GAZP, GMKN, MGNT, ROSN, MTSI, and other blue chips (in my understanding, through ADRs). Taking into account USDRUB volatility, RSX/RUSL/RUSS construction, and management fees, there can be some difference in movements of the Russian stock market and your investment. For example, MICEX dropped 14% from the end of January, while for the same time interval RSX dropped by 16%, RUSL dropped by 45%, and RUSS grew by 70%.

    As you can see, RUSL and RUSS can generate significant profits as well as significant losses - playing with a Russian bear is like playing in Russian roulette. So do your homework and think for thyself.

    Disclosure: I am long RUSS.

    Themes: Russia Stocks: RUSS, RUSL, RSX
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