We began writing this article a week prior to the conflict between Russia & Georgia. Our view of Russia has obviously not improved… In general, mutual funds with large Russian exposure have done very well over the past 10 years. This is in no small part to the rise in Russian GDP from their wealth in petroleum & natural gas. With Asian economies growing at an unprecedented rate, there is little reason for Russian GDP growth to slow. Except…

 
Political instability is the enemy of reliable economic growth. Russia has been the poster child for political instability for several years now. Vladimir Putin stepped down as President, allowing Dmitry Medvedev to assume the reigns.  But – as is typical Russian fashion – Putin is behind the scenes running the show (Russian history is littered with very powerful leaders that command from a supposed second in command post). 
Data:

  • The recent war between Georgia and Russia. Georgia is a former soviet satellite republic. In August, these countries clashed over control of a region within Georgia called South Ossetia. Georgia matters because:
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    • Massive quantities of oil & natural gas pass through it from Russia to it’s markets (Europe).
    • It borders several countries of strategic significance to the USA: Russia, Iran, Turkey.
    • Georgia is trying to become a NATO member and member of the EU. Germany & France blocked it from NATO this year.  
    • How Russia treats Georgia impacts other former soviet countries: Ukraine, Poland, Hungary, etc.
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    • Georgia is a small democracy and had 2000 troops supporting the US in Iraq.
  • The largest oil company in Russia – Yukos – was destroyed by the Kremlin via a claim for un-paid back taxes.  This resulted in the CEO ending up in jail (he’s still there).  Yukos is now owned by the state- and called Rosneft.  Rosneft is controlled by one of Putin’s friends.
  • TNK-BP is a joint venture by British Petroleum and Russian private oil enterprise.  The CEO’s work Visa ended recently and left  Russia rather hurriedly – perhaps fearing a similar fate to the Yukos CEO. The Kremlin’s fingerprints are not directly found in this dispute, but neither are they doing anything to protect BP share-holders.
  • Putin & his buddies are at it again. This time the target is mammoth steel and coal company Mechel. Mechel is listed on the NYSE (MTL). ON July 24th, Putin publicly accused Mechel of selling its coal abroad for lower prices than at home – and avoiding taxes. As a result of Mr. Putin’s efforts, MTLs stock has been pummeled (down from $52/sh to a low of $11) – now around $26/sh.

Perhaps the Kremlin is not concerned about losing international investors because international capital did not flee when Yukos was taken-over. From here, Russian growth is anticipated to slow. Inflation is in double digits, and oil production is falling.  Not where we want to invest.