The Russian Paradox: Mao Cheers While Lenin Spins In His Grave

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Includes: BNO, CRUD, DBO, DNO, DTO, DWTI, ERUS, OIL, OLEM, OLO, RBL, RSX, RUSL, RUSS, SCO, SZO, UCO, USL, USO, UWTI, XLE
by: Andrew Hecht

Summary

The oil crash is killing the ruble.

How much gold can you fit in the trunk of a Porsche?

Russians seeing red - a desperate Putin?

Russia's woes may ignite the Chinese economy.

When Vladimir Putin presided over the 2014 Olympic Winter Games in Sochi, I wonder if he had a feeling that moment would mark the height of his position in the world. It has been downhill since. In the wake of the games, the Russia leader took Crimea. Then, in a move that further isolated him from the rest of the world, he provided backing for pro-Russian forces in Ukraine. The battle in Ukraine continues. The United States and Europe responded by leveling multiple sanctions on Putin and his friends, the oligarchs, who lead Russian business. Sanctions curtailed capital flows into Russia. The Russian ruble closed 2013 at the 33-1 level versus the US dollar. By the end of October, sanctions began to take a bite out of the currency and it dropped to 43-1. Then at the end of November, things got really ugly.

The oil crash is killing the ruble

The latest and ugliest blow to the ruble was not the result of US and European sanctions. It came from the Saudis and OPEC. Russia is a huge producer and exporter of crude oil; in fact, the Russians produce over 10 million barrels of crude per day, which is around a 12.65% share of the world's output. In late November when OPEC meet in Vienna and decided not to cut production, the price of crude oil, which had been moving lower since summer, picked up downside steam. Crude oil is now trading over 46% lower than where it was just six months ago. Lower crude oil and other commodity prices have taken a huge toll on the ruble and the Russian economy. Isolated by the West, Russia is experiencing an intense meltdown in its economy, resulting in a deterioration of the ruble.

As crude oil prices headed lower in the wake of the OPEC meeting, the value of the ruble cratered and is now trading at 58.5-1 against the US dollar - a devaluation of more than 77% since the beginning of the year. A confluence of events has put enormous pressure on the Russian economy and its leader.

How much gold can you fit in the trunk of a Porsche?

Some Russians have made a lot of money since the breakup of the Soviet Union. A tremendous amount of that money remains in the country and given recent sanctions, it is having a hard way making its way out. Russians are now scrambling to find a way to convert the ruble, which is losing value quickly, into tangible assets that will retain value.

The Russian government has been a huge official sector buyer of gold this year. Russian gold reserves have tripled since the end of 2005. The Russians are big gold producers and it appears that all domestic production is now being held and not sold on the international market. Additionally, the Russian Central Bank has been a buyer of more than 150 tons of gold from international sources so far in 2014.

Russians with means, including the small group of oligarchs who control Russian business, are buying not only gold but also other tangibles to shield their wealth from the decline of the Russian currency. High-end automobile sales have exploded recently in Russia. In fact, everything from Apple iPhones and Gucci bags to refrigerators are selling like crazy as Russians rush to buy now and avoid the inflation that will surely follow the crash of their currency.

Russians are reacting to the current currency crisis by stashing wealth in items that will hold value. Some of those high-end cars - the Porsches, Bentleys and Ferraris - will have their trunks filled with gold bars. How long will it take before the crisis begins to undermine Mr. Putin's authority and popularity with the Russian citizenry?

Russians seeing red - a desperate Putin?

The propaganda machine of the Russian government is running at full steam. Given the weakening economy, reports that Mr. Putin's popularity is at 85% are highly suspect. The longer the economic pressure on Russia remains in place, the more dangerous it becomes for Putin from a domestic point of view. After the OPEC meeting, Russian officials aggressively pointed at the US shale business and said the cartels' non-action would destroy the economics of US oil production. Russians said that the shale business in the US would become unsustainable, forcing the high-cost producers out of the market, and oil prices would rebound once this happens. The Russians publicly pledged support for OPEC's position. What else could they have said? The Russians just smeared lipstick on a pig.

Fortunes have changed quickly for the Russians in 2014; sanctions and a falling oil price have forced the economy into a deep hole. The longer this persists and the deeper Russia slips into economic malaise, the tougher things will become for the Russian leader. Perhaps the biggest challenge will come from the powerful oligarchs who are seeing their wealth evaporate. As the situation has deteriorated, the Russian leader has been scrambling, and this may be playing right into the hands of a country that has traditionally been the biggest enemy of Russia.

Russia's woes may ignite the Chinese economy

Putin has recently embraced an increased dialogue and business relationship with the Chinese. In a series of agreements, Russia will be supplying China with a host of commodities, including crude oil and natural gas. The two countries have also set up a swap agreement so they can exchange local currency for trading purposes avoiding using dollars or euros.

In the meantime, China is the beneficiary of Russian woes. China will be buying energy commodities like crude oil from a desperate seller at market prices that are at the lowest level in years. China will be filling its coffers with crude oil at very low prices. The number of supertankers sailing to China jumped to a record in ship-tracking data signaling that the Asian giant plans to increase oil reserves at today's low prices. China can finance and store the oil at attractive levels with the market structure in contango. Deferred crude oil prices are at big premiums to nearby prices. That is the perfect market structure for China, a buyer of physical oil with a boatload of cash.

One of the biggest issues in terms of the global economy in 2014 has been sluggish growth in China. Sanctions on Russia, OPEC inaction causing a falling oil price and general pressure on commodity prices could be a shot in the arm for the world's largest consumer of commodities. Recent events in the world are providing a huge stimulus for the Chinese economy. The Chinese are picking the pockets of Russian oligarchs, buying oil at bargain-basement prices. The transfer of raw material assets from a scrambling Russia to a growing China is enough to make Mao cheer from the great beyond at the same time Lenin spins in his grave.

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