Why It’s Time to Buy the Cheapest Market in the World

by Carl Delfeld

To put it mildly, there is not much I like about Russia.

A couple of weeks ago, I highlighted to you Russia’s abysmal record on economic freedom. It ranks a pathetic #144 ranking in the 2012 Index of Economic Freedom.

Political freedom? What can you say about a government that puts a renegade band in jail for two years just because it doesn’t like their lyrics?

Still, I had to smile when I checked my Pacific Rim country portfolio this week and saw that the Market Vectors Russia ETF (NYSE: RSX) was the top recent performer - up around 18% since being added to the portfolio just a few months ago.

Given my antipathy towards the country, why on earth I did I add it in the first place?

It was, and remains, a dirt-cheap stock market.

According to the Financial Times, the Russian market is now trading at just 5.7 times earnings compared to 16.9 times for India, 15.1 times for the S&P 500 index, 19.4 times for the Philippines and 18.4 times for Mexico.

Is Siberia the Next Canada?

Why is it so cheap? Well in addition to the reasons I have already highlighted, Russia is one giant commodities play – an area out of favor with investors at the moment.

Roughly 70% of the Russian stock market is made up of resource stocks. The country is the world’s largest oil producer and the second largest oil exporter. On top of this, Russia is the world’s second largest natural gas producer and exports twice as much as its nearest competitor, Norway.

So when energy resource stocks are moving – so is the Russian market. Though, I have noticed that it always seems to trade at lower valuations than its peers. It’s also interesting to note that Russia has outperformed China over the last decade with a compounded return measured in US dollars of 325% versus China’s 247%.

Russia Finally Joining the WTO

There are also some developments that have recently made me watch Russia even more carefully…

First, just last week, after 19 years of painful negotiations, Russia finally joined the World Trade Organization (WTO). According to the World Bank, WTO membership will drive medium-term GDP up by 11% and could boost its growth rate by up to 3% per year. Under the terms, Russia must commit to a series of regulations that promise to energize domestic growth and encourage foreign investment.

In addition, maybe up to now protected industries will get moving through a dose of badly needed international competition.

Second, Russia is steadily shifting its attention and resources to its Pacific Rim frontier. Anchored by the city of Vladivostok, Russia is stepping up its trade and investment outreach to countries such as China, South Korea and Japan.

Why It’s Time to Buy the Cheapest Market in the World

(Source: Encyclopedia Brittanica)

In fact, over the past five years, bilateral trade with Japan has already doubled and trade with South Korea has tripled. This is just the beginning as the Pacific century unfolds.

In addition to ample supply of energy resources, Russia has geography in its corner. It takes only 2-4 days to get raw materials from Russia’s Asian frontier to China compared to weeks for many of its competitors.

Finally, despite the bad headlines, the Russian economy is chugging along pretty well with about a 4% growth rate. One of the largest food retailers and BMW sales are both growing at a 30% annual clip.

Pundits are always warning investors about “falling in love” with their stocks. I say be careful not to hate them too much – you will miss opportunities.

Good Investing,

Carl

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Home Court Advantage…

One message Carl has been trying to get across for the past few months is that emerging market multinational companies operate on a different playing field than U.S. investors are typically accustomed to.

The markets in these foreign destinations are rarely free, and government typically plays a large role in choosing the winners and losers. Like it or not, this is just how things are done in countries like Russia. Carl calls it “semi-market, state-capitalism.” And being that this isn’t likely to change any time soon, we may as well capitalize on it.

That’s why Carl recommends state-run monopoly Gazprom OAO (OTC: OGZPY) as a play on Russia’s growth potential.

Here’s what he wanted to share with Plus subscribers today:

“Russia's Gazprom OAO is easily the largest company in the country.

“This state-run monopoly owns the largest gas transportation system in the world, supplying natural gas to Russia. European countries have become increasingly reliant on it, too.

“Employing over 400,000 workers, Gazprom accounts for over 80% of Russia's natural gas production, and about 10% of its economic growth.

“Given its gas monopoly status, and its 50.002% control by the Russian government, Gazprom has been the focus of political concern of the countries it sells to. The central government, through its "representatives" controls investments, financial plans, and cash flows.

“They also control the valves that supply gas to Europe. Back on January 1, 2006 in one of the numerous natural gas price disputes with the Ukraine, Europe was shut off from Russian gas for three days.

“Gazprom is 15 on the Forbes list, and is a mainstay of funds that focus on the BRIC nations, emerging market countries (particularly European ones), and Russia. Gazprom will figure prominently in the world's supply of natural gas, and will soon be one of the largest exporters of liquefied natural gas (LNG).”

Gazprom is also close to its cheapest levels since the 2008 financial crisis and less than a third of its price just before the crisis. As always, we recommend a 25% trailing stop just in case the market moves against us.

– Justin Dove with Carl Delfeld

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