| Looking
At Russia ~ Investing In Russia ~ Page Three |
| THE
RUBLE |
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| The collapse
of most currencies in the Orient has drawn attention to the ruble as perhaps
the next to fall, and I think that's an excellent bet. Briefly, there are
several indicators that can point to an overvalued currency that's likely
to devalue: |
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| 1) Purchasing
Power Parity— If a basket of goods is much more expensive in country
A than country B, it might be because of local taxes or inefficiencies.
But it might also be because the currency is overvalued. The McDonald's
Big Mac, which can be easily found almost anywhere on the planet, is a
good rule of thumb indicator. |
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| I didn't personally
visit one of these emporiums of fine dining in Moscow, but I'm told Big
Mac's in Russia cost about 50% more than they do in the US. That's certainly
true of restaurant meals and hotel rooms, which is especially egregious
in a country where the average income is about 10% that of the US. Based
on that, the ruble is a great candidate for devaluation. |
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| 2)
Foreign Trade Deficits— One reason a country imports more than it exports
might be that it's living above its means, consuming more than it's producing.
That's absolutely the case with Russia. Devaluing the currency is one way
to reduce demand for imports. And most of the money in question isn't spent
on capital investment, but on consumption. So there's no prospect of these
deficits turning around. The ruble is headed down, bigtime. |
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| 3) Government
Spending Deficits— The Russian government spends a lot more than it
takes in; it finances part of the deficit by printing new rubles, but most
of it with debt. Instead of trying to collect taxes to cut its deficit,
it should cut its spending 50% or so. That, of course, would inconvenience
a lot of people who live off the government. Regardless of whether or not
they cut spending, it will almost certainly devalue, amounting to a de
facto default on its ruble-denominated debt. Which is one reason, along
with the rational fear it will print up lots of extra rubles to buy what
it wants, it has to pay up to 150% interest on what it borrows. |
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| 4) Government
Backing for its Currency— After having sold most of its gold during
the final days of the Soviet regime, the Russians are now said to be net
gold buyers. (Note: Russian gold production has fallen from a peak of 188.5
tonnes in 1987 to 120.3 tonnes in 1997). |
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| But all their
gold and dollars together are trivial relative to the rubles outstanding;
if the ruble was to be made redeemable with a fixed amount of gold, and
hence stable, maybe it needs to be devalued 80-90%. Right now its backed
mainly by confidence in the Russian government, something that only an
idiot would rely on. |
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| What would
be the consequences of a ruble devaluation? In Russia (and it's similar
in most Third World and state-directed economies, for that matter) only
relatively inconsequential volume (10% ?) of transactions take place
in rubles. About 20% take place in dollars. And about 70% are barter.
Rubles are used mainly by the average Russian, who doesn't have much in
the way of assets. He gets his salary, and pays his rent and groceries
in rubles, but even with 100 million people, this amounts to chicken feed.
Any large or important transactions, or those between people with some
sophistication, are done in dollars. Really big transactions tend to be
bartered, for several reasons. First, banks don't act like banks in the
West; they don't make loans. Basically they take deposits from the public
and then speculate with them. So there simply isn't available cash for
financing deals. Second, if there is any cash, then the State is going
to want it for taxes; bartering obviates that problem. |
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| I expect
the ruble, currently 6.26 to the dollar, will be devalued significantly,
probably to at least 10-1 within the year. The average Russian will
again be financially devastated, which has pretty much been the story throughout
history, including the last seven years, when he's seen his savings and
pension evaporate through runaway inflation. You might think the average
Russian, after all these centuries, has been genetically altered to allow
the acceptance of unlimited abuse. On the other hand, since the State is
no longer powerful enough to keep a tight lid on the pressure cooker, especially
in the face of the massive changes since the collapse of the Soviet Empire,
maybe the place is ripe for a real revolution. It's a tough call. My guess
is that a further disintegration of Russia, into a bunch of new nations,
is the most likely scenario. |
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| Russia, in
its present form, makes only somewhat more sense than the Soviet Union
did. Places like Chechnya and Tartarstan aren't the only candidates for
autonomy or independence. It's hard to see why much of eastern Siberia
will continue to send money to Moscow in return for a lot of aggravation. |
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| THE OLD
GULAG |
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| The Russians
have always been fond of bragging how big their country is. And it
is big, evidenced by the fact it took 8 hours to fly from Moscow
to Magadan which, although it's not nearly as far east as Vladivostok,
is in the same time zone as New Zealand. It's disconcerting being that
far north in mid-summer, since the sun had no apparent movement the whole
flight, either coming or going. In fact it never set in Magadan, and barely
set in Moscow. |
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| Anyway,
the place is big. But size isn't everything. The reason is that there's
nothing there. Picture far northern Canada, but with no infrastructure,
no amenities or conveniences, and no prospects. Actually it's much worse
than that, because it's not populated by good-natured Canadians, who are
at least there for some reason, but by chronically depressed and bad tempered
Russians who are there because of a cruel trick of fate. |
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| Just millions
of square miles of waterlogged muskeg, underlain by hundreds of feet of
permafrost, and absolutely covered with mosquitoes. The mosquito rules;
there are few or no large mammals because the insects will drive them crazy
within hours, covering their eyes so they can't see, and their nostrils
so they can't breathe. The tundra may serve some useful purpose in the
ecological scheme of things, but I'm unaware of it. I'd suggest using it
as a giant camp for Green Warriors, Earth Firsters, Deep Environmentalists,
and other assorted enviro-nazis to get a taste of the wilderness. Few have
the foggiest idea that nature, outside of artificially groomed national
parks, not only isn't our friend, but is pretty much dedicated to recycling
you as part of the food chain. |
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| But perhaps
it's somewhat indelicate to talk of putting people in camps up here, because
there were, in fact, millions of them in camps in exactly this part of
Russia up until the mid-eighties. The camps were located here for two
main reasons: One, it's so isolated that you don't have to build prisons,
as such; there's nowhere to escape to. And two, there's plenty of use for
cheap labor. Almost all the gold mined here—an estimated 80 million ounces
since the 1920's-- was placer, a type of mining which is labor intensive,
but takes little capital. Placer isn't favored for public companies because
it's hard to establish reserves; you're basically looking for free gold
buried in gravel. And free gold is easy to pilfer. |
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| The Russian
government has historically felt the need to develop eastern Siberia, not
because it was particularly worth developing, but because if they didn't,
the hordes from China would. |
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| The only thing
the Russians have ever been able to do here that makes even a semblance
of economic sense is mine gold. So that's what most of the Gulag workers
did. That, and build the infrastructure that catered to, and was paid for
by, the mining industry. |
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| I regret
to say that I've only read the briefest selections from Soltzenitzen, who
logged a number of years up here. Having seen the reality during the
summer, the most pleasant time of year, I'm really anxious to hear his
description of the winter. Of course you do hear stories. The city of Magadan,
such as it is, was mostly built by Japanese prisoners of war, almost all
of whom died. When they put in the docks, for instance, they worked naked
in the icy water; when they died, new prisoners took their places. When
a newly arrived boatload of prisoners tried to hijack their ship, the guards
simply turned fire hoses on them, and waited until the next day, when the
prisoners could be conveniently chopped out of ice by other prisoners.
There are plenty of stories like that floating around, so I won't retail
more to you. |
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| Magadan
itself is a pretty sorry looking place, even at the height of summer. The
winters must be something else entirely—endless darkness, constant sub-zero
temperatures, little or no fresh food, no entertainment other than vodka,
and the exclusive company of people who are such depressing losers that
they couldn't figure out how to escape. But it's obviously much improved
from only a few years
ago. There are now probably a dozen stores of various
descriptions in what passes for the downtown, and maybe a dozen restaurants.
Not bad for a city of 150,000, at least by comparison to other parts of
Russia. The place could have at least as much of a future as an Alaskan
coastal city, if only because of fishing. But only it became a true free
port. Complete freedom could literally make the dark side of the moon a
paradise. In the meantime, why should people or capital come here? Indeed,
how to keep the people and capital that are already stuck here from leaving? |
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| Barring
radical change, most of the artificial cities the Soviets created in Siberia
should, and will, turn into ghost towns. There's nothing left of the
gulag camps, which were basically shantytowns. They've just blown away.
I flew around Magadan region for about six or seven hours in an MI-8, and
can promise you that one square mile looks just like thousands of others
around it. About a week after I left, three people were killed and another
thirteen injured when another MI-8 went down in Irkutsk after catching
fire; about half the passengers were foreigners there to look at mining
prospects. For years I've felt, whenever getting off a Soviet-era aircraft,
as if I've dodged a bullet. |
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| INVESTING
IN RUSSIA |
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| I regret
to tell you that one of the decades great speculative opportunities slipped
right by me a few years ago, when the Russians privatized their industry
by passing out vouchers that allowed people to buy into any of about 127,000
companies that the State spun off. It wasn't the way I would have done
it, or the method I pitch to governments today, but at least it got industry
out of direct State ownership. If, for instance, 100 vouchers were offered
for a company, then each voucher would get 1% of it. Most Russians didn't
have a clue what the vouchers were worth, nor what the companies were worth,
so people who went there with briefcases full of money made unbelievable
killings. But that was pretty hard work. The good thing about Russia being
as screwed up and volatile as it is, is that there will be ample similar
opportunities to do the same thing with publicly traded shares, again and
again, as time goes by. The market here should be as volatile as that for
junior mining stocks. |
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| There are
a lot of good stories concerning Russian stocks. Incidentally, US-traded
stocks probably the only way to go, at least if you want stock quotes and
communication from the company. |
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| One example
is the TyumenAviam Trans ADR (TYAVY, US$5), which flies about 100 fixed
wing and 225 rotary wing aircraft in the province of Tyumen, in far western
Siberia. The liquidation value of the aircraft alone are conservatively
several times the value of the 6 million ADR's outstanding, not counting
its ownership of a number of airports. Revenues have grown from US $70
million in FY1994 to US $165 million in FY1997, and the company is selling
for a P/E of perhaps 3 or 4 to 1. It's hard to be sure about things like
earnings, though, because of uncollectable receipts, barter deals, and
the like. Another example is Gazprom, a natural gas conglomerate, which
is the largest company in Russia in terms of employees (most of whom should
be fired) but, more importantly, in terms of revenues. It's estimated to
own about a third of the world's natural gas reserves, and if it was valued
like a western company it would sell for 100 times its current price. Even
though it accounts for about a fourth of the Russian governments revenues
right now, the comments I quoted above from Tax Collector Fyodorov were
directed at this company in particular. Which partly accounts for its low
price. |
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| The story
is similar for oil companies, where reserves go for a few cents a barrel.
There are lots of stories, but this isn't the time to get into them all.
When the time is right to buy Russia, a closed-end mutual fund should be
the foundation of your position. Two are available: Morgan Stanley Russia
(RNE, US$X, 13% discount), and Templeton Russia (TRF, US$X, 22% premium).
TRF has a better performance record to date, and that accounts for its
premium. I'd probably still go with RNE, however, since I want a ply on
the market, not any particular manager. |
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| When should
you get into Russia? Why not wait until the ruble goes into freefall, which
will probably be accompanied by a political crisis. I'll let you know what
I think in the months to come. |
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