Russia: Is it Time to Invest in One of the Coldest Countries on Earth?

Of all the unpleasant societies in which to live, Vladimir Putin's Russia is among the nastiest. Journalists and businessmen disappear, a knock on the door at 3:00am can prove fatal, and nothing gets done without endless side-payments to obscure fixers.

Still, Goldman Sachs Group Inc. (NYSE: GS) in 2001 identified Russia as one of the four great "BRIC" growth economies. And while much of its gilt has been worn off, Russia still has many supporters in the investment world. So the question is: Provided you don't have to live there, is it worth devoting a few of your investment dollars to the country?

The Economist is reasonably bullish on Russia. Its panel of experts predicts the country's economy will expand by 4.8% in 2010 and 4.0% in 2011, after shrinking by 8% in 2009. That's better than it looks, because Russia – unlike many emerging markets – has negative population growth of around 0.4% annually. That means a 4.8% expansion in 2010 gross domestic product (GDP) would actually translate into 5.2% growth per capita. That would boost living standards at a pretty rapid clip.

What's more is that Russia's inflation problem seems to have stabilized. The inflation rate is expected to run at just 6.4% in 2010, compared to 12% a year ago. The current account balance is heavily positive because of high oil prices, and while the projected budget deficit – at 3.9% of GDP – is a worry, it's not out of control.

In fact, with oil at a range of $70 to $80 per barrel, the flow of resources into Russia is sufficient even for the public sector. And the economy is open enough that business can survive and flourish. That sets it apart from other oil-dependent countries, like Venezuela.

Finally, Russian stocks are relatively cheap. The market trades at roughly 9-times earnings and it's just about flat on the year. It remains about 30% below its peak of early 2008. So with decent growth and reasonable valuation, there ought to be a few bargains around.

However, property rights pose a bit of difficulty. Time and again, attractive assets have been swallowed up by state-owned entities with connections to the Kremlin. Admittedly, President Dmitry Medvedev is attempting to open up the economy. But with only 21 months to go in his term, and Putin waiting in the wings, he probably won't achieve very much in the short time remaining.

As a small retail investor, the danger to your property rights comes not from somebody ripping off your 500 shares (at least, not if you buy them in New York), but from somebody ripping off the company you've invested in. A lot of Western investors were left without compensation after the great dismemberment of Yukos Oil Co., for example.

Investing in Russia thus requires the opposite approach to investing in China, where the state also is corrupt and inefficient but property rights are well respected. There is little point in buying shares of medium sized private companies – particularly at exalted valuations – because of the danger that a change in regulations or simple expropriation by some greedy politician could destroy the business.

Conversely, where valuations are low, the sluggishness of the big state companies is not such a disadvantage, particularly in the oil and gas sector where Russia is highly globally competitive. (However in steel for example, the 13.2-times earnings of Russia's Mechel OAO (NYSE ADR:MTL) looks overpriced given the alternatives elsewhere such as South Korea's Posco (NYSE: PKX), which trades at just 9-times earnings.)

In any case, the extractive sector is the area where Russian management has a high skill level and where the country's abundance of natural resources give it the most advantage.

Some suggestions would be:

• Lukoil (PINK: LUKOY): Lukoil is a major oil producer, primarily in Western Siberia. It also operates refineries and filling stations, some of them in the United States. The stock trades at 5.2-times earnings and has a 3.4% dividend yield. At current levels, it's still less than half its 2008 high. That makes it a risky but beautifully priced oil play, which will do very well f prices rise.
• Gazprom OAO (PINK: OGZPY): Gazprom is the successor to Russia's state-owned natural gas company. It extracts and transports natural gas through pipelines extending increasingly into Western Europe. At just 5-times earnings, it's even cheaper than Lukoil. However, the increased ability to extract shale gas, large deposits of which exist in Poland, may reduce gas prices as well as the chokehold Gazprom has on its customers in Europe. I prefer Lukoil.
• Wim-Bill-Dann-Foods OJSC (NYSE ADR: WBD): Outside the oil sector, WBD is one of the few attractive companies available to invest in. It manufactures and sells dairy, baby food and beverage products, primarily in the Russian Federation. However, it's not cheap at 23-times this year's earnings – although earnings are expected to rebound.

Finally, for general exposure to the Russian market, there's the Market Vectors Russia ETF (NYSE: RSX), which with a volume of $1.9 billion and a price/earnings (P/E) ratio of 10 may well be the best entry into the Russian market.

Even your money probably doesn't want to live in the Russian market full-time. But the occasional visit, to the oil sector or through RSX, could be lucrative.

[Editor's Note: Why is it that Money Morning's Martin Hutchinson has been right on the money with every one of his political predictions for each of the last three years?

The answer is quite simple. The same skills that made him a successful global merchant banker – where he was easily able to identify winning trends for his clients – also make him one of the very best political prognosticators.

Just look at some of his most recent global predictions. Earlier this year, just a week after Hutchinson recommended Germany, the European keystone reported much stronger-than-expected GDP. He recommended Chile back in December, and three of the stocks he highlighted have posted strong, double-digit returns – and one is up nearly 25%. He again recommended Korea – which analysts were downgrading – only to have the traditionally conservative International Monetary Fund (IMF) come out with an upgraded forecast that projects solid growth for that Asian Tiger for this year and next.

A longtime international merchant banker, Hutchinson has a nose for profits instincts – as evidenced by his unerring ability to paint a picture of what's to come. He's able to show investors the big profit opportunities that are still over the horizon – while also warning us about the potentially ruinous pitfalls hidden just around the corner.

With his "Alpha Bulldog" investing strategy – the crux of his Permanent Wealth Investor advisory service – Hutchinson puts those global-investing instincts to good use. He's managed to combine dividends, gold and growth into a winning, but low-risk formula that has developed eye-popping returns for subscribers.

Take a moment to find out more about "Alpha-Bulldog" stocks and The Permanent Wealth Investor by just clicking here. You'll find the time well spent.]

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