What’s Driving Russia’s Outperformance?

03/29/11 San Antonio, Texas – The Russian MICEX Index, which increased 22.5 percent in 2010, has jumped 15 percent so far in 2011, significantly outperforming many other markets.

China is the second-best performer of the BRICs, rising more than 5 percent, while India (down over 10 percent) and Brazil (down over 2 percent) have lagged. Overall, the MSCI Emerging Markets Index has dropped just over 1 percent.

This has effectively recoupled Russia with the other BRIC countries. The Russian economy lagged out-of-the-gate once the global recovery began, leading some to question whether it belonged in the same category as Brazil, China and India. Those sentiments seemed premature and symptomatic of an anti-Russia mindset.

Russian’s outperformance has been driven by several factors. First, the Russian ruble has appreciated 7 percent against the U.S. dollar, boosting stock market performance for U.S. investors.  This development also has a long-term benefit as a strong ruble benefits the country’s domestic sectors, something we’ll discuss later.

A second factor driving Russia has been the geopolitical and natural disaster events that have transpired during the past few weeks. Russia is relatively safe from the type of political uprisings seen in the Middle East and North Africa. Its government is decidedly popular with the public and the one-two punch of President Medvedev and Prime Minister Putin give the government clout on both international and domestic fronts.

The price of oil has risen roughly 25 percent since the unrest and turmoil began in the Middle East and North Africa.  As an energy exporter of crude oil and natural gas, Russia is one of the few large economies in the world that directly benefits from higher energy prices.

Russia is the world’s largest oil producer and it’s estimated that for every $10 increase in the average annual price of oil, Russia’s revenues rise by $20 billion, according to the Financial Times.  Since Russia is not a member of OPEC, it is not bound by production caps and can increase production as it sees fit while prices are at elevated levels.

Russia is also the world’s top exporter of natural gas and Stratfor Intelligence points out the situation in Libya has shut down 11 billion cubic-meters of natural gas flow to Italy. As Europe’s third-largest consumer of natural gas, Italy has turned to Russia for gas supplies. In addition, a shutdown of several Japanese nuclear facilities could mean as much as a 14 percent increase in natural gas consumption to meet the Japan’s energy demands.

In the energy sector, the Eastern European Fund (EUROX) portfolio emphasizes companies that show strong growth in production, reserves and cash flow, relative to their peers. Specifically, Novatek, Rosneft and TNK-BP fit this profile.

Russian energy equities, which carry the largest weighting in the MICEX, have gained 25 percent this year. This is higher than non-oil Russian equities, which have risen only 7.7 percent. However, as oil and gas taxes swell the government’s revenue, these funds are increasingly allocated to social and public works programs which are likely to create an opportunity for non-energy related equities. These sectors appear poised to benefit from the current macroeconomic environment.

This table from Merrill Lynch shows the performance of the different sectors of the Russian market following a sustained rise in oil prices. Merrill Lynch compiled research on the seven instances where oil prices rose 20 percent in a two-month span and maintained at least half those gains over the following six month period.

Historically, the average gain for Russian equities is more than 34 percent. While energy generally jumps out ahead when oil prices move higher, you can see that it lags other sectors as the rally progresses. We have long been positive on both Russian financials and the consumer sector and these sectors appear well positioned going forward.

Consumer-oriented equities such as retailers have historically been the best performers, netting an 85 percent gain on average and triple the gain of energy equities. Retailers X5 and Magnit should be able to capitalize on these trends. Russian financials are next with an average 83 percent gain. Sberbank, Russia’s largest bank, is the largest holding in EUROX.

Another area that could directly benefit from the Kremlin’s cash-filled pockets is infrastructure. Russia is in dire need of a significant revamping of its infrastructure. Similar to the American Society of Civil Engineers report that rates America’s  infrastructure a “D,” the World Economic Forum says the quality of Russia’s infrastructure lags that of other emerging countries such as South Africa, Turkey, China and Mexico.

The areas most in need of upgrading are Russia’s transportation and electrical power grid. The quality of Russia’s roads ranks in the bottom-third in the world, according to Merrill Lynch, and it’s estimated that Russia loses 6 percent of GDP each year due to underdeveloped roads. In fact, the combined length of Russia’s roadways declined 6 percent between 2002 and 2010 despite a 60 percent increase in car penetration, Merrill-Lynch says.

It’s a similar story for Russia’s airports and rail network. Russia currently has roughly 300 operational airports but just 40 percent of them have paved runways and 30 percent do not have an airfield lighting system, Merrill Lynch says. The rail network, almost entirely constructed during the Soviet era, is highly concentrated in the Western region of the country and is estimated to require more than $70 billion in investment for upgrades and repairs by 2020, according to Merrill Lynch.

Russia’s aging power grid is unreliable and accident prone. Merrill Lynch projects that significant investment by 2020 is required to update and modernize the grid. With industrial consumers accounting for 85 percent of electrical consumption, keeping the power up and running is essential to maintaining Russia’s industrial production levels.

To finance the much needed infrastructure improvements, the Russian government created the $420 billion Federal Target Program (FTP). The FTP focuses on key transportation areas such as rails, autos, marine and civil aviation.

The FTP has specific goals to meet by 2015 such as increasing the percentage of roads that meet federal standards by 23 percent. The plan also calls for a 47 percent increase in the shipment of goods and a 40 percent increase in airline penetration through improvements of aviation infrastructure.

In addition to the FTP, three special events will help drive Russia’s infrastructure spending: The 2012 Asia-Pacific Economic Cooperation (APEC) Summit, 2014 Winter Olympics in Sochi and the 2018 World Cup. Merrill Lynch estimates that total spending for the World Cup will reach $50 billion. Construction for the Games in Sochi includes 161 miles of roads and 65 miles of rails, and the APEC calls for 48 new objects to be constructed for a total of $83 million.

While higher energy prices are in danger of slowing down consumers in the U.S., Western Europe and certain emerging market countries, it has the opposite effect for the Russian economy. With increased cash flow from its natural gas and crude oil exports, the Russian government has the much needed capital to invest in the country’s aging infrastructure and to support domestic consumption.

This should drive outperformance of Russian markets throughout 2011 and stimulate demand for infrastructure-related commodities such as crude oil, copper, cement and iron ore.

Regards,

Frank Holmes,
for The Daily Reckoning

P.S. John Derrick and Tim Steinle are co-managers of the U.S. Global Investors Eastern European Fund (EUROX), and they both contributed to this commentary. For more updates on global investing from me and the U.S. Global Investors team, visit my investment blog, Frank Talk.

Frank Holmes is chief executive officer and chief investment officer of U.S. Global Investors Inc. The company is a registered investment adviser that manages approximately $4.8 billion in 13 no-load mutual funds and for other advisory clients. A Toronto native, he bought a controlling interest in U.S. Global Investors in 1989, after an accomplished career in Canada’s capital markets. His specialized knowledge gives him expertise in resource-based industries and money management. The Global Resources Fund was also Morningstar’s top performer among all domestic stock funds in the five-year period ending Dec. 31, 2006.

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Is the Anglosphere Driving Militant Islam?

Assassination underscores religious intolerance in Pakistan … News of the assassination came to Rev. Majed El Shafie at 3 a.m. Wednesday morning in Toronto. That was when Peter Bhatti, a fellow Christian living in Canada, called to say that his brother, Shahbaz Bhatti, had been killed in Islamabad. Peter Bhatti was “brokenhearted,” Mr. El Shafie recalled in an interview. “He called me to get the rest of his family to Canada from Pakistan. He was like, ‘I beg you, just help me get them out of Pakistan.’” Shaken by the overseas death of his long-time friend, the clergyman added: “How much more blood until people wake up about freedom of religion in Pakistan?” – Globe and Mail

Dominant Social Theme: Why can’t the East be more like the West?

Free-Market Analysis: The assassination of the Christian Minister for Minorities in Pakistan, Shahbaz Bhatti is a tragedy on a number of levels. The mainstream media has explained the tragedy rather well (see excerpt above) emphasizing the horrors or intolerance and Islamic fundamentalism. But in this article we want to examine the idea that the whole story has NOT been told and that institutionalized intolerance is often seeded and cultivated by the Anglosphere as part of a larger divide-and-conquer strategy. In Pakistan and generally throughout the Middle East we would argue that this is so.

There is no doubt the shooting of Bhatti is a shocking and tragic event. It was also a bold one. He was shot by masked gunmen in broad daylight, according to the Globe and Mail Report, after visiting his mother in Islamabad. “The assassination is yet another sign of Muslim-majority Pakistan’s slide into fundamentalism and anarchy,” the Globe and Mail observes, and indeed it is.

Of course, Bhatti was a target in Pakistan, which has grown increasingly intolerant of outside religions other than Islam (presumably Sunni Islam). And Bhatti may have made himself more of a target with what the Globe and Mail calls his (outspoken) contempt for Islamist extremism. “He openly campaigned against sharia law, and had spoken out against a 25-year-old blasphemy law that he felt singled out non-Muslims in Pakistan. Such pronouncements, he frequently acknowledged, made him a marked man. In fact, he prepared several videotaped messages to be broadcast in the event of his death.” Here’s some more from the article:

“The forces of violence, militant banned organizations – the Taliban and al-Qaeda – they want to impose their radical philosophy in Pakistan,” he said in one. “I’m ready to die for a cause. … I would prefer to die for my principles, and for the justice of my community, rather than to compromise on these threats.” Canada’s Immigration Minister, Jason Kenney, was particularly affected by the death of Mr. Bhatti, whom he considered a friend. “I was struck by how resigned he was about his expected martyrdom,” Mr. Kenney said in a statement. “He told me that he would not marry, because he did not want to leave a widow or orphans behind when that time came.” …

Mr. El Shafie, who hails from Egypt’s persecuted Christian minority, had worked on several other projects with the Bhatti brothers over the years. (Peter Bhatti was en route to Pakistan Wednesday to mourn his brother.) “I knew Shahbaz for the last six years. We worked together in many, many ways. He was like a brother,” Mr. El Shafie said. “He believed in what he was doing and he died for what he believed.” … Al-Qaeda and the Pakistani Taliban are apparently claiming responsibility for Mr. Bhatti’s death.

What occurs to us however is that if one tracks the genesis of the current rising extremism, it begins to look less like a homegrown exercise and more like a program of deliberate Anglo-American power elite provocation. This conclusion can be reached if one accepts the generally held perspective that Saudi Arabia – an Anglo-America client state – has been in the business of exporting Wahhabi fundamentalism for a number of decades. It is Saudi Arabia in particular that has helped fund various fundamentalist Sunni movements including the Madrassas in Pakistan and the Al Shabob regime change in Somalia.

It is well known by now that the CIA assisted in shaping the initial presence of Al Quaeda in Afghanistan to oppose the Russians. The Taliban, radicalized Pashtun warriors, were in many cases educated in Saudi-Arabia funded Madrassas. Everywhere one looks there is considerable funding (via Saudi Arabia of course) that supports Islamic fundamentalism and extremism. Supposedly, the Saudis have spent close to US$90 billion prosletyzing for Wahhabism throughout the Islamic world in the past 20 years. it beggars common sense to believe however that if the US were disconcerted by this spending that the Saudis would continue it.

We have spent considerable time recently explaining how we believe the current Western-initiated wave of regime change sweeping the Middle East may replace “strong man rule” with Islamic republics. The idea, always, is to polarize religious ideologies in order to create tension between East and West. Anglosphere money power then exploits this via military actions and by imposing further authoritarian mechanisms on its own citizens.

In the era of the Internet there is perhaps considerably more awareness of this sort of manipulation than in past eras. Daily India for instance yesterday carried a remarkable speculation about the assassination entitled “RAW, MOSSAD or CIA could be behind Pak minister’s assassination.” The report was derived from a Pakistani publication, the Nation. The Daily India news brief summarized the Nation’s perspective, reporting that a “foreign hand” could have furthered the assassination.

The report acknowledges that the assassination has been claimed by the Tehrik-e-Taliban-Pakistan, which has apparently been behind a string of terrorist attacks in the country. But it then points that “Links between foreign intelligence agencies like RAW, MOSSAD and CIA and militants have been suspected. RAW [Indian intel] is even known for having provided financial and military support to spread violence in Pakistan,” it added.

What would be the justification for such attacks? According to Daily India, the Nation speculated that it was “pretty much apparent” that those who carried out the assassination “would have in mind the consequences for our image abroad and the anxiety it would create within the religious minorities.”

The paper also apparently made the claim, according to “well-informed sources”, that the Obama administration “deployed over 400 pro-India and pro-Israel CIA agents in Islamabad, Quetta, Peshawar, Lahore and Karachi, the country’s biggest cities.” It added that these individuals came from private security companies like LLC, Xe services or Blackwater and that leading Indian and Israeli tycoons have been “secretly and heavily funding such companies to carry out clandestine operations in the Middle East, Asia and Africa as per their interests.”

This sort of paranoia – justified or not – is reinforced by current events, specifically the recent capture of a US diplomat, Raymond Davis, who shot and killed three Pakistani men and remains in a Pakistan jail. We reported on this recently in an article entitled “Unraveling of a Pakistan Scam” and quote part of a ZeroHedge.com article entitled “CIA Agent Caught Red-Handed Aiding Pakistani Terrorism?” The cut-line reads, “News that the American accused of killing two Pakistani men is a CIA contractor has intensified an already highly charged situation in Pakistan.” You can see the article here:

http://www.thedailybell.com/1786/Unraveling-of-Pakistan-Scam.html

Fundamentalist zealotry, especially leading to murder, is always tragic. But what is even more tragic in our view is the inextricable involvement of the West in inciting these sorts of activities in furtherance of a divide and conquer strategy leading to further control of the developing world. Instead of helping these countries prosper, the Anglo-American power elite seems content to cultivate extremism as part of a larger program of destabilization and infiltration.

Conclusion: Whether such programs can continue to work in 21st century – when publications such as the Nation and Daily India speculate in real-time on these supposedly top secret machinations – is a question we regularly submit in these modest pages. This is perhaps the dilemma that the Anglo-American elite faces in the Internet era.

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