The Dangers of Investing in Russia: Worse Than they Seem

Bank of America/Merrill Lynch Warns About Investing in Russia

Analysts Fail to Point out the 2 Biggest Dangers!

I have been warning about the dangers of investing in Russia for several months.

I have made the argument that Russian President Vladimir Putin’s nostalgia for and obsession with restoring the Soviet Union, including his history of seizing private assets to amass a personal fortune of an estimated $70 billion … makes investing in Russia very dangerous.

Unlike most global stocks, which started showing signs of bottoming Friday after a rough couple of weeks, a few things on the horizon have the ability to trigger a devastating financial meltdown in Russia.

And even though Russia can’t count on help from the U.S. or European markets, Western nations should brace for what could be a ripple effect …

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$80 Oil Has Been Putin’s Achilles’ Heel

The recent sharp decline in oil prices is an issue.

What’s more, Putin’s insistence to continue a client state relationship with both Iran and Bashar al-Assad’s Syrian regime by financing arms sales is a looming factor.

Not to mention, the serious sanctions imposed by the U.S., the euro-zone and their allies. 

On top of all of this, the price of crude oil has slid well below the $117 a barrel Russia needs to get for its crude to stay profitable.

That means Russia now faces the prospect of massive deficit spending at a time investors around the world have been dumping Russian stocks, bonds and currency.

In just in the past four months alone, the Templeton Russia and East European Fund (TRF) has slid 22.5% since June.

Although Russia’s state-run oil and gas giant, Gazprom (OGZPY), just reported a positive quarter and the stock popped in response last week, its profit for the first half of the year slipped 23%. The company is now reportedly in talks with a Chinese bank to obtain funding.

Yet, Bank of America (BAC) and Merrill Lynch analysts still see "resilient fundamentals."

In a BAC/Merill Lynch note, published last week after a meeting in Moscow with fellow economists, analysts, ratings agencies and government officials, Vladimir Osakovsky, Arko Sen and Oyin Anubi wrote:

"One expert said progress in inflation-targeting might raise the issue of capital controls, because the Russian FX market is dominated by a very small number of exporters and banks. This point proved to be timely, as it was quickly echoed by recent press reports of the Central Bank of Russia contemplating capital controls as a contingency plan for rising outflows.

"Despite resilient fundamentals, we think Russia still carries massive headline risks, which complicate a proper assessment of the situation. Of these, the Ukrainian crisis clearly remains the key threat to the macro and policy outlook, but general concerns related to the crisis appear to be on the decline. … Therefore, although there are tail risks of renewed escalation, there are no fundamental reasons for a re-escalation of the crisis in the near future.

"We find OFZ [federal loan obligation] valuations increasingly interesting, but do not think that yield levels have peaked. … 10-year yields are likely to peak above 10% and maybe even near 10.5%. On our trip, we did not see sufficient evidence to change this initial estimate. Though a short-term rally could occur led by positioning relief, a sell-off into year-end would then look likely as inflation remains on the rise. The year-end redemptions profile is also potentially negative for (the ruble currency).

"Thus, unless the CBR [central bank] surprises positively by announcing a large and inexpensive FX repo facility, we do not expect a final turn in sentiment yet. Size/timing of rate hikes from the CBR to control inflation expectations, more RUB support or stabilization and better Q1 seasonality thus remain the key triggers/timing we continue to watch."

The burden of currency controls, according to the note, could send 10-year yields to a high of 10.5%.

I think these well-respected analysts are seriously misjudging the dangers that the Russian economy is facing.

Russia’s volatile risk due to Putin’s delusional obsession with a rebirth of the Soviet Union — plus its authoritative, territorial expansionist policies — may make it impossible for the country to borrow in the international markets at anything close to the levels BAC/Merrill Lynch analysts are warning.

Interestingly enough, on Oct. 8, Russia’s Finance Minister, Anton Siluanov, issued a statement warning that Russia cannot afford the military expansion and modernization Putin has been hoping to accomplish.

Yet, just five days later on Oct. 13, he went against his statement out of nowhere; coaxing investors back to Russian business by saying Russia is still a "very profitable" bet for firms.

Upon facing interviews and meeting foreign investors in Washington D.C., Siluanov said:

"We just keep telling them that Russia is a good place to invest and they shouldn’t be afraid to come to Russia and do business with us."

Well, I wonder who is behind that…

Image Credit: Yahoo! Finance

The Russian Stock Market has been in a steady decline trend since Putin was re-elected the country’s president.

I wouldn’t be surprised to see 10-year yields climbing closer to 18% in the next 12 months, if crude oil prices fall to $75 a barrel as suggested in the Barron’s Oct. 3, 2014, cover story.

While BAC/Merrill Lynch analysts reference Russia’s supposed "resilient fundamentals," I am at a loss for what they are talking about.

Russia’s cash reserves and modest government debt may be structural advantages, but they were built on climbing commodity prices during the past several years.

Now, the tide is clearly turning against Putin’s Russia.

Even Putin has noted Russia’s big structural weakness of being all too reliant on high commodity prices.

The Russian ruble has taken a beating over the past few years while President Putin has pretended the Soviet Union and its policy of confrontation have been reincarnated.

Bank of America and Merrill Lynch, like so many multinationals doing business with and in Russia, are afraid to admit to the dangers Western companies face in doing business in or with the country.

At any moment, Putin could nationalize and steal all foreign investments and assets in Russia.

Beware of the dangers and do not be swayed by Russian hearsay. Russia’s dangers are real and should not be downplayed.

Always Watching Your Chickens,

James DiGeorgia

P.S. Russia may be in deep trouble, but the U.S. midterm elections are just around the corner, and the 6 months after midterms are historically great for U.S. stocks.

Since 1949, the Dow has risen an average of 7.3% in the fourth quarter of a midterm election year. And for the most part, this election boost continues on during the next year … with the Dow rising an average of 16.9%!

And in a brand-new video being released tomorrow at noon Eastern, you’ll discover the exact steps you need to take to prepare yourself for Nov. 4 and beyond. We’ll send you all the details when you click this link here.