Russia, Dollars, Oil and Kitchens

Paul Goncharoff

With temperatures now dipping to zero in Moscow most people here tend to traditionally gather in warm toasty kitchens and spend quality time indoors nattering about this and that. One of the many favourite themes these past few years, are of course ‘the sanctions’. If they were not so keenly seen by the average Russian as unjustified interference, they would be accepted as comedic farce. Shakespeare wrote, ‘Now is the winter of our discontent’ where King Richard III muttered his feelings of disappointment at living in a world that hates him. Similar sentiments are often shared around kitchen tables here even by people without royal humps.

Popular sentiments aside and taking a factual non-politically correct view; why is it that Russian stocks are increasingly the beacon of light for many emerging market investors? Perhaps this is based on (gasp) economic fundamentals? Not a popular thing to view in our algo-trading times.

Valuations are at historically low levels, the median average price/earnings ratio for Russian companies is in the region of seven, compared with 12 and higher for other global emerging markets. Dividends are rising, the Russian treasury is flush with reserves, the budget is in surplus and the outlook for oil despite recent declines looks to remain long-term solid.

Today Russia is acknowledged as the cheapest, lowest priced emerging market. The fly in the ointment are the perceived geopolitical risks confronting investors primarily due to increasingly unpredictable, almost emotional economic pressures exerted by a dominantly US-led lobby.

The spectre of expected further sanctions screw tightening, mostly by the new midterm elected majority of house democrats in Washington may get ugly as that party remains focused on Russia (while the republicans have moved on, shifting their bets and ire mainly against China). For example, today Russian government bonds pay close to 9% in roubles over inflation of less than 3%, and remain as of this writing unsanctioned. Hopefully this will remain so, as interfering with a nations sovereign debt position may well be a step too far.

In any case, this unpredictable geopolitical spat does keep away all but the most committed and brave investors from engaging. The threat of escalated sanctions is fully as effective as sanctions themselves in our risk-averse, increasingly spooked investing world. The one growing exception seen are certain Asia based investor blocs that increasingly take a different, positive view of the opportunities in Russia, and are channelling their investments to rouble denominated instruments on the MOEX, as well as directly into developing projects on the ground.

Meanwhile, from the Russia side efforts are ongoing to remove the risk of a hostile Dollar and the increasingly volatile geopolitics of trading in that currency, especially the petrodollar. The Russian energy majors are pressuring Western oil buyers to use euros or other currencies instead of dollars for payments and introducing penalty clauses in an effort to protect themselves against possible new U.S. sanctions. It has been strongly rumoured that as of 2019, some Russian contracts (if still priced in dollars) may call for buyers to pay penalties for supplies should more new unforeseen U.S. sanctions disrupt sales.

Russian businesses are busily preparing to meet and handle yet a further new wave of sanctions, which given the geopolitical excesses seen recently in the US&EU, are expected to happen just after this new year (the US administration has taken a holiday sanctions season time-out). The preparations are largely expressed by methods to diversify away from dollar payments and by sourcing Asia for the greater portion of financing and technology needs rather than anywhere dominated by shifting US Dollar policies.

Russia today supplies more than 10 percent of global oil; therefore, adding any more draconian sanctions against it could lead to a steep spike in oil prices – which is not politically or economically acceptable to DC. Equally pertinent is that most world oil majors rely on Russia to feed their refineries, especially in Europe and Asia, and must now, to a greater degree than they might like, share the risks and burdens that any further new amped-up US sanctions may have on their economies and this new era of “contingently free-trade”.

Meanwhile, back at the Russian kitchen tables, many are wondering what new problematic dramas will be thought up by the creative ‘west’ to make lives even more entertaining, and ensure that we all will live in complex ‘interesting times’.