In 2014, Russia successfully attempted to annex Crimea, an act which infuriated pretty much everyone to the west of Moscow. Sanctions were applied, harsh words were spoken. The ruble ( lost 60% of its value, from 34 to nearly 80 rubles per dollar. The conflict in Ukraine remains a reality, despite a ceasefire in place, and just recently the European Union decided to prolong the sanctions. Everybody talks about how there is massive inflation (15.8%) and recession (-2.2% YoY GDP) and how it is affecting the Russian currency.
This, however, is absolutely not so. Sanctions, uncertainty and the general international ostracism have had little to no effect on the ruble, nor had the release of the currency from a fixed exchange rate toward free float. Pretty much all changes in the currency value are traced back to oil.
The covariance of daily closing prices between crude oil and USD/RUB is 84.2%. Eighty-four per cent of all ruble movements are explained by changes in oil price. Every time oil gains, so does ruble (USD/RUB goes down), and conversely, every time oil prices fall, USD/RUB goes up. The correlation is best shown on the graph below, calculated as USD/RUB multiplied by oil prices, to account for the negative .918 Pearson correlation:
As you can see, fears over the war with Ukraine and the change to a free-floating ruble amounted to a two-day spike on December 16-17, 2014. Other than that, the ruble has followed oil prices in the same corridor as it did in 2013, when Russia was an esteemed G-8 member and Ukraine was a peaceful country. The only thing changed by the ruble's free float is the high volatility, but it is a sideways volatility. ruble is Oil, and not much else.
Consequences for Trading
There are some very good trades resulting from this unusually high correlation. Especially since USD/RUB is a currency pair with quite a high base interest rate.
First off, a hefty and relatively safe income can be made by selling USD/RUB (buying the ruble) and hedging it against oil (selling oil). The carry trade benefits, although smaller than several months ago, are still a very good deal (depending on your broker you can get up to 12% p.a. in forex swap points with the current base rate). The oil hedge protects you from 84% of the currency risk. Even better, if you have access to Russian bonds, buy them and hedge against oil. No wonder Russian bonds sell like fresh pastry on a Monday morning. Moreover, most of the turmoil around Russia is over, and with Putin striking deals all over Asia, the sanctions are more painful for the EU than for their recipient. Russia is stabilizing and slowly getting out of the 'scary' recession phase, and outlook is good.
Secondly, why trade oil if one can trade USD/RUB? Of course short positions should still be taken in oil, as the swap points for a long USD/RUB are pure loss. for long oil, however, USD/RUB is an alternative offering very similar properties, with a hefty interest rate on your money.
Thirdly, for USD/RUB itself, it seems the worst phase is over and a return to over 3600-3700 points on the graph above is unlikely, showing signs of stabilization. If the oil glut is resolved, the ruble will quickly recover toward pre-Crimean levels, even if sanctions remain in place. We have seen USD/RUB at 49 with Brent at $70, it is at 56 with Brent at $60. Brent at $80 would mean USD/RUB below 43, however unrealistic this may sound right now.
Disclosure: I am/we are short USD/RUB.
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.