Russian equities have taken a dive in the last month due to a drop in oil prices and the unpleasantness in Georgia. Investors are scared that the tiff in Georgia and the US placement of a missile defense shield in Poland will reignite, or refreeze rather, the cold war hostilities between Russia and the West. Last Thursday the Russian Central bank reveled that it has lost 16.4 billion USD in foreign reserves in the pervious week- bringing their reserve total down to 581.1 billion USD.

Here is why I don’t think the globe will not re-freeze:
1.    Today Europe, even Western Europe, is heavily dependent on gas and oil shipments for mother Russia. The US and their European Allies understand that they need to keep the energy flowing from Russia.
2.    Russia is also needs a market to sell their energy in. If they rock the boat too much, they will not be able to use existing infrastructure to transport and sell their energy.
3.    President Medvedev seems very pro-business and seems to want to create a friendly investment climate. And although he may be a patsy now – remember how obscure Putin seemed when Yeltsin made him his successor? Medvedev could very well be the future of Russian economic policy.

What’s going on right now?
My best guess is that Putin, the real power in Russia, is trying to keep oil prices high. As Russia is the world’s largest producer of oil (take that Saudi Arabia), its economy is heavily dependent on high oil prices. The recent commodity boom has been a real boost to Russia’s economy and Putin knows that his popularity as a dictator is dependent on whether or not he can keep the petrodollars flowing. If oil was to fall back to a more reasonable 60 dollars per barrel then Russia’s economy could lose some of its steam and Putin could lose his support of the people. Let’s not forget, that during his eight year reign as president, Russia’s GDP increased 6 fold, and poverty was more than cut in half. Average monthly salaries increase over 150% on an inflation adjusted basis- hell you would probably be happy if your salary kept pace with inflation!

Best ways to play a Russian rebound
If the globe does not freeze over again, there is going to be a rebound in Russian equities. The safest way to invest in Russia’s currently unsafe economy is though the market vectors Russia ETF, RSX. This ETF offers exposure to Evraz Grp SA (EDR), Gazprom Neft ADR, Gazprom OAO (EDR), Lukoil Company ADR, Norilsk Nickel ADR, Novolipetsk Iron & St, OJSC Oil Company Rosneft, Sberbank Rossii OAO, Surgutneftegaz, and Uralkali Jsc. But I would prefer to buy Mechel (MTL), which plummeted after Putin made some harsh remarks in late July. But Mechel’s punishment, once thought to be a possible bankrupting fine – was nothing more than a slap on the wrist. In my opinion ( see past articles I’ve written on Mechel’s valuation) Mechel is very undervalued and will revert back to fair value in the future.
If you have any questions/comments/just want to tell me to go to hell – feel free to e-mail me at domenic@domenicstrazzulla.com

Disclosure Long MTL

Mechel (MTL)