So the story goes. A weak dollar means strong commodities and strong commodities means high oil prices. Russia has benefited all year from oil prices over $100 a barrel and as a result, the Market Vectors Russia (RSX) exchange traded fund has outperformed its BRIC market peers and the MSCI Emerging Markets index over the last 12 months. The biggest Russian ETF traded in New York is up 26.5% year-to-date ending June 2, while the MSCI Emerging Markets index is up 24.3%. In the first five months of the year, Russia's stock market has outperformed Brazil and India's, and beat the MSCI Emerging Markets index. Only China has done better, but those gains have only come in the last few weeks.
"A weak dollar means buy oil and gas, and in that scenario I'd buy the Russian market through RSX," says Vlad Signorelli, president and chief strategist at boutique investment research firm Bretton Woods Research LLC in New Jersey.
All four of Russia's most popularly traded energy stocks -- Gazprom, Lukoil, Rosneft and Novatek, were all up by double digits in late March before declining with oil prices. Still, majors like Gazprom are beating the local index, up 3.3% YTD ending June 2. Rosneft and Lukoil are both up a little more than 6%.
What makes Russia attractive given the ongoing global weak dollar phenomenon?
For starters, Russia is the world's leading natural gas producer and is home to the largest proven natural gas reserves. It also ranks No. 8 in the top 10 oil producing nations, according to the Oil & Gas Journal, an industry trade group. Outside of Opec, of which Russia is not a member, the country is the No. 2 after Canada of non-Opec oil producers.
The big oil and gas firms account for more than half of the Russian Trading System stock index, which is the reason why the Russian trade is so highly correlated to oil futures. When oil goes up, Russia often follows.
"Russia is the most correlated equity market in the emerging universe to oil prices and many investors trade Russia as a hedge on the oil price," says Jennifer Delaney, a strategist at UBS in New York.
"A weaker dollar that coincides with higher oil prices would therefore be good for Russia," Delaney says. Investors would be buying Russia not because the dollar is weak, but because oil is strong, even if the two often do go hand in hand. The weak dollar leads to higher commodities and that inevitably means higher crude prices and that has some investors bullish on Russia. In the short term, the US dollar and oil have been highly correlated. However if this were to break down, the path of oil price is more important to Russia than the level of the US dollar.
"We continue to like Gazprom and Lukoil," Delaney says. Both are in UBS Global Emerging Markets Select portfolio of their 40 best stock ideas. UBS also holds Gazprom in its $555 million Global Emerging Markets Equity fund.
Yet, while a weak dollar means higher oil prices, higher oil prices also means more dollars and euros flooding Russia to import oil and gas. That means a stronger rouble.
Tatiana Orlova, an economist at Nomura in Moscow, thinks that the weak dollar is not beneficial for oil companies because their revenues are dollar-denominated, but their costs -- like wages -- are mostly rouble-denominated. "A weak dollar may prompt oil and gas companies to invest less into exploration and development, which would weigh down on growth," she says.
The weak dollar is causing problems for Russia, too, primarily through food inflation. The Bank o Russia raised the bank deposit rate last week due to 9.7% inflation as of May 23, up from 9.6% in April. The official inflation target is 7%, so with some real rates at -1.2%, cash has little to no value. Investors should expect more interest rate hikes to come, likely 25 basis points, according to Barclays Capital in Moscow.
Disposable incomes in Russia fell 6.5% in April and unemployment rose marginally to 7.25%. For all the weak dollar-strong commodity hype, one would think Russia would be awash in capital and abundance. That might be the case for Moscow's uber-wealthy, but average Russians seem to be muddling along, judging by the last set of lagging indicators released by Rosstat for April.
Overall macrotrends in Russia remain week despite bullish calls on oil in the markets. The government needs to raise rates to help keep inflation under control. A weak dollar is helping oil companies, but the weak dollar-strong commodity story has not been a good one this year due to home grown systemic risks to the economy. That might mean investors who don’t have to be in Russia, but like the idea of higher oil prices and a weaker dollar will turn to other ways to play this trend rather than buying RSX or the Russian energy companies.
"The recent period is, indeed, quite unusual for Russia, where historically high oil prices -- particularly above $100 per barrel-- have given a strong boost to the domestic economy," says Vladimir Pantyushin, an analyst at Barclays in Russia. "This time I believe uncertainty about the on-going recovery and growth prospects have been exacerbated by next year's election. As a result, we see weak investment activity and consistently high capital outflows."
Russia vs MSCI Emerging Markets
6m 1y 5y
Market Vectors Russia (RSX) 5.98% 26.53% -2.14%
Wisdom Tree India (EPI) -10.03 7.67 -6.32
iShares MSCI Brazil (EWZ) -3.58 15.25 36.02
iShares FTSE Xinhua (FXI) -1.04 12.80 21.51
iShares MSCI EM (EEM) 2.43 24.28 15.83
