4 Reasons Why Russia Isn't Doomed

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Includes: BIK, BKF, EEB, EMDD
by: The Panoramic View

Summary

In the long term, given its educated work force, Russia has a good probability of successfully diversifying its economy.

If Russia pulls out of Ukraine, the ruble will appreciate in value, and interest rates will fall.

Crude prices are unlikely to stay low in the long term. When crude rallies, the Russian economy will improve dramatically.

When the herd heads for the exits and group think becomes infectious, prices fall far below what impartial people think is rational or even possible.

And yet history shows that the best time to buy is when there is blood on the streets and everyone thinks the same way.

To an impartial investor, it is very clear that there is blood on the streets in Russia right now.

Everyone is bearish. The ruble is down a lot. Russia's economy is heading into recession, with the Russian government forecasting a 4% contraction for 2015. Anything Russia related suffers from headline sanction risk due to the Russian-West geopolitical tensions over Ukraine.

Things have gotten so bad that the combined market capitalization of Russian stocks listed on the Micex is lower than the market capitalization of Apple or Microsoft.

To be fair, things do not look like they will turn around any time soon. Russia depends on crude oil for a large portion of its exports and budget revenues. Because it depends on crude for so much of its trade, the ruble is basically a crude oil proxy.

With OPEC not cutting production, crude oil will likely remain low in the short term, meaning the ruble will remain weak. Because the ruble is weak, the ruble is in danger of speculative attack if Russia does not keep interest rates high. If interest rates remain high, Russia's economy will remain in recession for the foreseeable future.

Still, there is some reason for optimism from a long term perspective.

First, despite the brain drain in recent years, Russia still has a very educated work force. That work force has arguably not been put to good use over the past decade as the Russian economy basically rode the wave of rising commodity prices. Now that Russia has more incentive to diversify, it will. Given the intellectual talent, and the incentive to do so, the odds are good that Russia will succeed in diversifying its economy in the long term.

Second, China stands to lose a lot if the Russian economy deteriorates much further. China prizes external regional stability almost as much as it prizes internal stability. China also covets Russia's energy and materials. Given that China has trillions in foreign currency reserves, China has the resources to backstop Russia. China will help Russia if Russia needs it.

Third, if Russia pulls out of Ukraine, one can reasonably assume the Western sanctions will be lifted, and many Russian companies will refinance in Western markets. If sanctions are lifted, the ruble will appreciate, interest rates will fall, and Russia's economy will recover faster. While there are no hard indications that Russia will leave Ukraine, Putin did not mention the word 'Novorossiya' (a term Putin used to justify Russia's actions in south-east Ukraine) in his recent state of the nation address. The absence of the term may presage peace in Ukraine and an eventual thawing of Russian-West tensions.

Fourth, crude prices are unlikely to remain low in the long term. China's economy should recover in a few years and Saudi Arabia and OPEC will eventually have to raise the price of crude to pay for their social programs. Once crude prices rally, the Russian economy will recover.

For short term investors, Russia is not a good investment, because calling the bottom of any crisis is pretty much impossible. Cheap can get a lot cheaper. For investors with investment timelines of a decade or more, there are many compelling reasons to be long Russia.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.