Russia’s Problems Impede its Long-Term Profit Promise
By Martin Hutchinson
Contributing Editor
Money Morning
For global investors searching for long-term profit plays, the message is clear: Don’t spend a lot of time looking at Russia.
Russia’s Pravda, formerly the official organ of the Soviet Communist party, published a blistering attack on the United States last week. That would not seem so strange, except that the attack accused America of “descending into Marxism.”
Meanwhile, the Russian stock market has doubled since January and the price of oil – Russia’s principal export – has nearly reached $70 per barrel. Though it seems an extraordinary question to ask, we still have to ask it: Does the Russian economic model have something to teach us?
The writer of the Pravda article clearly enjoyed penning it. There were a lot of barbs about the United States, such as “the population was dumbed-down through a politicized and substandard education system based on pop culture.”
There also were some attacks on the United States’ policy toward Russia in the 1990s: “The initial testing grounds was conducted upon our Holy Russia and a bloody test it was.”
But then there is the claim that “Prime Minister [Vladimir] Putin warned [President] Obama and [former U.K. Prime Minister Tony] Blair not to follow Marxism, it only leads to disaster.”
Enjoyable though it is to imagine the Russians lecturing the Obama administration about sound economic management, in reality they have no grounds to do so. A few months ago it appeared that the Russian economic model would not make it through 2009, as the state spent the last of its oil revenue to prop up both the banking system and the dodgier politically-connected oligarchs.
A country that was wealthy when oil was $140 per barrel became deeply impoverished when oil prices dropped all the way down to the $30 range. Those of us who had been alarmed by Russia’s increasing geopolitical and economic assertiveness indulged in a little schadenfreude, feeling that it couldn’t happen to a nicer bunch of guys.
Now, the table has turned again. At $68.87 a barrel, the price of oil is far higher than the price assumptions on which the majority of Russia’s oilfield-investment calculations were based.
Russia has effectively seized the assets of the British oil company BP PLC (NYSE ADR: BP). Last week BP accepted the very unpleasant Mikhail Fridman as chairman of its joint venture TNK-BP, a sign that its attempt to control the investment into which it had put the majority of the capital was ended. In the long run, the forced expropriation of foreign investors will prevent the Russian oil sector from remaining truly competitive. But in the short run, the expropriated foreigners have found so much oil there that huge revenues are assured for at least a decade, provided the oil price remains reasonably high.
In other sectors, too, the free cash for those with political connections allows deals to be done. Opel, for example, General Motors Corp.’s (OTC: GMGMQ) European subsidiary, was sold not to the Italian company which had a strategic plan for it, nor to the Chinese company that could use it to enter the European market, but to Magma Group, a Canadian parts company controlled by Russian interests, with financing from the Russian state-controlled bank Sberbank Rossii OAO.
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The result may not make much sense operationally, but it is another example of Russian interests controlling major strategic assets in Europe. Needless to say, the various gas and oil joint ventures undertaken by Gazprom OAO (OTC ADR: OGZPY) in Eastern Europe, the Mediterranean and North Africa are also extensions of Russian power.
The fact that Russia’s MICEX stock index is up 100% since early January (albeit still 40% below its December 2007 high) is not very relevant to the people who run Russia.
They appear to have two objectives: Using the capitalist system to make themselves and their colleagues very rich and projecting Russia’s power on the world stage – just as the former Soviet Union used to do.
To Prime Minister Putin, capitalism is an attractive discovery, because it works economically much better than Communism did, and thus allows Russia to regain more of its former power than would have been possible under the Soviet system.
In this sense, Putin and current Russian President Dmitri Medvedev have finally achieved the original goals of Mikhail Gorbachev’s reforms in the 1980s; the objective of those was certainly not to bring down the Soviet government or upset the system, but simply to get the economy working more efficiently towards the leadership’s objective of greater Soviet power. Minus the other ex-Soviet Republics, Russia has now achieved this objective – and it may not stay minus the other Republics for very long, if Russia’s rulers have their way.
Given the way the system is rigged against the outsider, Russia is not a particularly attractive place to invest. Clearly, there may from time to time be a good short-term bet that Russia’s rulers will overcome current difficulties. However, the world contains other good managers besides Putin, and some of those others have a genuine interest in shareholder value and determination to create more of it.
By all means, look for Russian companies in consumer sectors that are outside the grip of the oligarchs – but do not expect to do too well, because you may find your company has a new and very expensive sleeping partner. Probably the best vehicle is the Market Vectors Russia ETF (NYSE: RSX), which benefits from Russia’s still-low Price/Earnings Ratio of 7.2.
But remember this: Russia isn’t a great global growth market like China, India or Brazil. And without major changes, it never will be.
News and Related Story Links:
- Money Morning:
Russia Expands Role in U.S. Energy Sector with Uranium Deal - Money Morning:
China-Russia Oil Accord a Sign of a Changing World - Money Morning:
With Russia’s Economy in a Deep Freeze, Is Medvedev Gearing Up to Give Putin Das Boot? - Money Morning:
Russia’s Politics of Isolation Leave it Economically Stranded in a Time of Crisis. - Pravda:
American capitalism gone with a whimper.
Comment by K Alexander on 5 June 2009:
“Descending into Marxism” is exactly what is happening in the US.
Alexander Solzhenitsyn said once “the lie is the pillar of state”.
Everyone seems to know this but Americans.
Comment by motelbill on 5 June 2009:
This is not unusal. I lived in St. Pete when a dispute arose between, of all firms,….The Subway Food Chain and a Russian Partner…..The outcome was Subway (and I believe the store was company owned and not franchised) partner had no recourse in Russian Courts. If they did how would they get an injunction enforced? It will always be interesting times in Russia, especially Moskva!!!!
Comment by Trev on 5 June 2009:
Just another article attempting to divert us away from the biggest joke in the world today and that is rigth here at home where stupid politics and greedy economics really have succeeded in creating a true dissaster and distruction of once a beautiful and wonderful country. What was once a country offering life at a wonderful level of prosperity and joy to a country of stupidity and fraud which is well on it’s way to a probabilty of variables including extensive poverty, crime ( physical and economic ) and a with all the miltary migth available, to blow us up back into the stone age.
Comment by j lamont on 5 June 2009:
They are correct. The USA IS, descending into Marxism.
Don’t you think so???
Comment by Joel Markham on 5 June 2009:
You are incredibly misinformed and write with a glib tone that is striking. Lets start with the vrey unpleasant Mikhail Fridman comment, your judgement is based on ….
Magna (not Magma) is one of the larget tier suppliers in the gloabl auto industry and has been responsible for the design and manufacture of several of the best known autos in Europe (including the BMW X3). Magna has made its intentions ot continue up the vertical integration path well known for many years and in fact had been in talks with Damler to buy Chrysler (and Lord knows woudl have been better suited to the task than Cerebus). Sberbank owned a big chunk of Magna as a result of a default on a loan it made to Basic Element, the owner of Russia’s largest car maker. Russia is Europe’s second largest car market and it is very likely Opel will be merged once it is stabilized.
If you look at the cycle over cycle returns for Russian equities, you will find they outperform the US indices, even on a risk adjusted basis.
Government participation in industrial policy is a fact, and there have been one or two very obvious cases of abuse, but many if not all of the Russian companies are free to operate with shareholders the boards appoint. There are pressures from outsiders who want to be in the business but if you have the right local partner this risk is reduced. Anyone who doesnt do this when investing intenationally is subject to same risk. Russia is not Chicago, and anyone who expects it to be so is naive.
Lastly, the best of all the comments, Russia is not a global growth market like China or Brazil…. No, but it resembles Australia or Canada in terms of its resources profile and has a pretty large market around it which it can serve. In a world of double digit inflation I like that profile more than that of big commodity consumer.
Go back to getting your worldview at the local diner.
Comment by V Todres on 6 June 2009:
Well, should I start numbering inaccuracies?
- The size of the rainy day fund and whether it was indeed fully spent?
- who exactly was it not expecting Russia to survive 2009?
- who are Magma? POssibly, Magna, a Canadian company who in fact got rid of the Russian control because the Russian shareholder could not answer on margin calls?
- when was BP’s Russian unit nationalised? It has been owned by BP 50% and still is. And, even with Fridman as execitve chairman, it is operated by the BP team (COO, CFO, etc)
- and so on and so forth
I have liked your commentaries so far, but now I wonder – was it only because I did not know that much about these other topics of yours? What if the rest of your commentary was the same type of misinformed, inaccurate redneck nonsense as the article above? Where are you writing from – Des Moines, Iowa?
Probably I should take your opinions with much more than a pich of salt now
Comment by NoSocialism on 6 June 2009:
‘It takes one, to know one.’
Makes perfect sense that a Russian would be able to articulate what many Americans don’t want to admit.
To many of us though, it’s perfectly clear.
Comment by Robert on 6 June 2009:
The U.S. does indeed have the misfortune of being led by a malicious Marxist right now, hell bent on trying to destroy the greatest country ever built, while fervently believing everything the Marxists who raised him taught him, all of it founded on lies. I followed the link from the “Gone with a Whimper” story on Pravda to the author’s blog. His view is definitely colored by the Russian point of view, but he did make some valid points in his article. I agree with his assessment that the “educational” system has been deliberately dumbed down and the kids who go through it are being stuffed as full as a Christmas turkey with loads of irrelevant pop culture and present-day Leftist crap about man-made global warming, Marxist idiot-ology, perversion promotion, etc. Having read John Taylor Gatto’s book, “An Underground History of American Education” (available at http://www.johntaylorgatto.com), it’s easy to agree with the assessment of an intentionally dumbed-down forced-schooling system based on the old Prussian model, mixed with elements of the Hindu caste system. I wonder if the author is aware of a document (a KGB memo, I think) from about 1962 that the CIA translated after the fall of the Soviet Union, when it became available, which suggested infiltrating the schools to implement destructive actions on Western societies, particularly the promotion of homosexuality as innocuous, or even positively, as a way to destroy rival societies. The author had another post on his blog where he talked about the Russians disrupting gay-pride marches in Russia where Western gays tried to put on parades in Russia. Quite ironic that Russia is now desperately trying to stamp out the effects of the poison seeds of perversion that its KGB sowed decades ago throughout the Western world.
Comment by Frank Banano on 7 June 2009:
Hey I like Russia too. Here’s another good article, It’s a great read, On Investor’s Daily Edge site:
http://www.investorsdailyedge.com/the-russia-pick-i-recommended-to-you-is-up-39-in-53-days.html
Thank you,
Frank
Comment by Giovanni on 7 June 2009:
If the article writer holds that Russia has not grounds to do so, I strogly believe that America (the establishment)together with their cusins British, after becoming two huge hedge funds and debt producers have lost any ground to teach how to govern the economy. About marxism and national socialism
(fascism+nazism) I suggest everybody to read the folowing books by Antony G. Sutton:
Wall Street and the Bolshevik Revolution
Wall Street and the Rise of Hitler.
Regards.