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Wednesday, August 30, 2006

Getting the Russian Market Wrong

An article about the Russian stock market by one Maria Ermakova, published in Bloomberg News and excerpted in the International Herald Tribune is wildly misleading. La Russophobe reproduces it below, with running commenary (in red) to clear up the confusion. There's so much of it that La Russophobe can't help but wonder if this reporter has been bought and paid for by the Kremlin.

Russian stocks are approaching $1 trillion in value, an emerging-market record, mostly because of the country's burgeoning oil industry. In other words, the only reason the market is up at all is that the price of oil has risen. It has nothing to do with any growth or dynamism in the Russian economy or any particular enterprise, and if the price of oil falls your investment will evaporate. More important, foreigners are being systemmatically excluded from access to Russia's oil resources.

"Russia has a great potential,'' said Jacob Grapengiesser, who helps manage $4 billion at East Capital Asset Management AB in Stockholm. "There has been political stability, the economy is strong, and things are getting better for people, not just the market.'' The firm has about half its holdings in Russia. A person who spends his life convincing people to invest their money in Russia so he can collect a commission is perhaps not the best source of objective information about how good an opportunity actually is. He may be slightly biased. Just a word to the wise.

The Russian Trading System Index has surged 88 percent over the past 12 months. OAO Gazprom, the country's natural gas monopoly, ranks as the world's third-largest company at $276.9 billion, behind Exxon Mobil Corp. and General Electric Co. and ahead of Microsoft Corp. and Citigroup Inc. As La Russophobe has previously reported, in just a few weeks at the beginning of the summer the Russian market lost one-third of its value, the biggest plunge in its entire history. Wouldn't it have been appropriate to at least mention this fact?

Investors have looked past deterrents such as President Vladimir Putin's seizure of OAO Yukos Oil Co. to reclaim control of the energy industry. The Russian index, a dollar-denominated gauge of 50 companies, is the third-best performer in the past year among 80 benchmarks tracked by Bloomberg. Actually, that's a boldfaced lie. The number of people who have invested in Russia's stock market is microscopic; its investors consist primarily of a small group of wealthy elites known as "oligarchs." This reporter really should get out more.

Russia's market capitalization on Aug. 16 reached a record $946.2 billion, 15 percent larger than South Korea, the next biggest emerging market, at its peak in May, according to data compiled by Bloomberg. A July share sale by OAO Rosneft, a state oil producer, added $68 billion in value to the market. As reported on La Russophobe. this IPO was lampooned and castigated across the globe because the company is being manipulated by the Kremlin and is founded based on misappropriated assets. A fool and his money are soon parted.

Shares of Moscow-based Gazprom, the world's largest natural- gas producer, have jumped 60 percent this year. The same thing can happen when you put money in a slot machine. But they don't call them one-armed bandits for nothing.

Banks, Mobile Phones

The country's biggest companies outside the oil and gas industry include OAO Sberbank, Russia's biggest lender; OAO Unified Energy System, the national power utility; OAO GMK Norilsk Nickel, the world's largest nickel miner; OAO Cherkizovo Group, Russia's largest meat producer; and OAO Mobile TeleSystems, eastern Europe's No. 1 mobile-phone operator. Notice how she doesn't tell you anything about the performance of these companies? Two such major enterprises just posted multi-million-dollar losses, as reported her on La Russophobe.

The price of the country's main oil export, Urals crude, has soared 164 percent in the past five years. The surge has boosted earnings prospects for energy producers in Russia, the world's second-largest crude exporter behind Saudi Arabia. During the past 12 months, it's up 17 percent and touched an all-time high of $73.63 a barrel on Aug. 7. "I am not surprised by market valuations,'' said John Lomax, an emerging markets strategist at HSBC Holdings Plc in London. "Given high oil and gas prices it is likely to continue this way. The Russian market may come down a little but in the long term it will outperform other emerging markets.'' Investing in Russia because it has oil is like investing in Nazi Germany because it has auto factories. Maybe not the best long-term move you can make.

Greater Weight

Institutional investors are according Russia a bigger place in their portfolios. Morgan Stanley Capital International said this month it will almost double Gazprom's weighting in the firm's Emerging Markets Index to 5 percent in September, making it the biggest component of the benchmark. The firm took the step after Putin dropped limits on the stock's foreign ownership. About $3 trillion in investments is benchmarked to MSCI's indexes. If he can drop them, he can raise them. Doesn't anyone remember Mikhail Khodorkovsky?

Vanguard Group, the second-largest U.S. mutual-fund manager, last week added Russia to the countries in its $9.6 billion Emerging Markets Stock Index Fund. Previously Vanguard excluded Russia on concern that it was too hard or risky to trade in. The country now warrants inclusion in the fund, the Valley Forge, Pennsylvania-based firm said. $9.6 billion is nothing for Vanguard, and Russia is a neglible part of that nothing.

Record initial public offerings in Russia also helped boost the value of the market. Russian IPOs may total $18.3 billion this year, surpassing the record $4.6 billion in 2005, according to Renaissance Capital, a Moscow-based investment bank. Rosneft's July IPO raised $10.6 billion, making it the world's fifth- largest public offering. OAO Magnit, a food retailer, raised $368 million in April. The stock market is worth $1 trillion and there are less than $20 billion in IPOs? Not very impressive.

Impact of Yukos

Moscow-based Rosneft in 2004 bought the largest unit of Yukos, which was seized and auctioned by the government to help recover more than $30 billion in tax claims against Yukos. Yukos once was Russia's biggest oil exporter, and the government's seizure of the company and prosecution of its founder, Mikhail Khodorkovsky, raised concern that Putin didn't respect private property rights. Yukos was declared bankrupt Aug. 1. The Moscow-based company, valued at $43 billion less than three years ago, now has a market value of $1.8 billion. "The case with Yukos has clearly hurt the market, but it's over,'' said Grapengiesser. "People have moved on from that period of time.'' Again with the Russian broker! Isn't this just a bit much? Of course, Russia has gotten over that silly business with the gulags too, now hasn't it?

Dependent on Commodities

To be sure, many investors say that Russia's nominal market value of $942.2 billion overstates its size, because it includes shares owned by the state and thus not available for trading. The government, for example, owns more than 85 percent of Rosneft, more than 50 percent of Gazprom and almost 64 percent of Sberbank. Index providers such as MSCI exclude shares held by the government and other equity not available for trading. The firm counts only $178 billion of Russian market value in its stock indexes. Wow, at last some truth! So that business about the $1 trillion up front was total B.S., wasn't it. And yet you mention it, and the truth is buried way down here. Gee, La Russophobe dares to wonder why.

The market also is captive to swings in commodity prices, which may be depressed by slower economic growth in the U.S. and China, according to Guenter Faschang from Vontobel Asset Management in Vienna. "The risk is quite high that the U.S. and global economic growth will slow,'' said Faschang, who manages about $1 billion. "This will cut demand for commodities and raw materials, and their prices will go down.'' The firm has been selling holdings in Russia and eastern Europe. And what about U.S. efforts to find replacement oil supplies, such as the gigantic Canadian shale project? What about conservation? What about Cold War II? What about the possibility that Vladimir Putin, a proud KGB spy, will run Russia right into the ground just the way every other leader of Russia has done since the beginning of recorded time?

`Bubble' Fear

Russian Economy Minister German Gref in March said he was "very afraid of the formation of a so-called bubble'' in the stock market. The RTS has risen 12 percent since then, and it's outperforming other emerging markets this year even after a slump in May and June. The Russian index is up 46 percent year to date versus an 8.3 percent gain for MSCI's emerging markets index. A slump? The market lost one-third of its value in the largest one-day crash in its history, and she calls it a slump? Seems like Gref was spot-on in predicting the bubble, but the "reporter" ignores it.

Concern about political stability in the country as Russia prepares for presidential elections in 2008 may also weigh on the stock market, said East Capital's Grapengiesser. "The risk of course is commodity prices and who will succeed Putin,'' he said. "I don't think it's going to be much of a problem, but with Russia, you never know.'' What exactly would you expect a Russian stock broker to say? Get your money out while you have a chance, you fool? I want to go to the poor house?

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