It's been a choppy year for just about every asset class, perhaps none more so than shares of anything connected to commodities. Emerging markets have suffered with weakening currencies -- against a stable U.S. dollar -- and threats (though no actual evidence) of global deflation. If growth is slowing or turning negative in the economies to which emerging markets export their natural resources (iron ore, copper, steel, etc.), then a slowdown in the activity/production of said goods is inevitable. Emerging market currencies and equities were strong when the growth of their largest trade partner, China, was still soaring.
But there is one emerging market whose health doesn't depend on China's appetite for iron, copper, or steel: Russia.
Sure, Russia is generally viewed by the West as lawless, corrupt, and uninvestable. But should it be seen that way?
1. The Russian ruble has never been viewed as a stable currency, but in December of last year, before the oil rout had really set in, the Russian Central Bank hiked interest rates (from 10.5% to 17%). Of course, that would be unheard of here in the U.S., but that swift and decisive action has worked to stave off the ruble's decline. The level at which the ruble stopped falling has served as strong support ever since.
2. Outside the Middle East, Russia is probably the economy most closely tied to crude oil and natural gas (so its prices are incredibly important). I'm not about to call for a massive rally in crude oil or natural gas -- both of which are still flirting with multiyear lows -- but at this point I don't believe there is much remaining doubt that we are, at the very least, in a bottoming process. The U.S. media seems very focused on domestic production, which only makes sense, and that has indeed fallen from a peak of 9.6 million barrels per day (bpd) to 9.1 million bpd. But there are still no other potential bullish catalysts being priced into the price of oil. It doesn't seem that anyone is considering the possibility of production declines anywhere else, or global demand improving, even modestly (if only due to low prices).
Russia's primary export markets are in Europe, hence its lack of dependence on China (as of third-quarter 2014 China represented just 14% of Russia's oil and gas exports). But this number is up from just 9% four years earlier as President Vladimir Putin is aggressively helping Russia's big oil CEOs to secure long-term contracts for oil and natural gas with China's state-owned oil companies.
According to the Guardian: "In 2013, Russia's largest oil producer, Rosneft, signed an $85bn deal with China's Sinopec to deliver 100m tonnes of crude over 10 years. On top of that, Rosneft struck a $270bn deal to double oil supplies to China. Last year, a 30-year deal was signed by the state-owned gas company Gazprom worth $400bn to deliver gas to China."
Any continued stability, or improvement, in the prices for crude and natural gas would have to be viewed as wildly bullish for Russia's economy and stock market.
3. A popular index for Russian shares, the Market Vectors Russia ETF (RSX), currently yields more than 4% and is demonstrating technical strength by just about every indication. It should be no surprise that the top holdings of this index are oil/gas producers and banks; due to the extremely concentrated nature of Russia's economy, the health of both is very much tied to crude oil and natural gas.
So, I believe the No. 1 risk here is -- shocker -- geopolitical. But with a reasonable stop (just below the 50-day moving average), this trade could be an enormous winner from a risk/reward standpoint. And you get paid while you wait, at twice the rate of the 10-year U.S. Treasury bond.