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Summary RSX is down 10% since by initial bear thesis article was published in June. I can’t call it a success and I surely expected more downside. I discuss the reasons for this underperformance and the outlook for RSX. Back at the end of June, I published an article titled RSX: The Bear Thesis , where I outlined my thoughts about the direction of the Market Vectors Russia ETF (NYSE: RSX ). My main points were the weakness of the ruble, the poor state of the economy and bearishness on oil prices. I mentioned cheap valuations of Russian companies as the main factor for the bullish thesis, but stated that these valuations were chronic and that I did not expect them to provide significant support for RSX. How the thesis played out so far On June 26, when the initial article was published, RSX closed at $18.28. On October 27, RSX closed at $16.47, declining 10% from the day when the initial thesis was published. During this period, RSX was volatile: it touched lows of $14.00 and then rebounded to $17.81 before sliding to current levels. At the same time, USD/RUB, which closed at 54.78 on June 26, increased to 64.90 on October 27. Brent oil declined from $63.05 to $47.03. Thus, oil declined 25.5%, the ruble declined 18.5% and RSX declined only 10%. I can’t call it a bad idea but I’m a little bit disappointed because I expected more downside. I think it is time to revisit the thesis and see why it did not play out as well as I expected and whether there is still more downside possible. Why RSX gained more support than I expected I strongly believe that the lack of interest rate adjustment in the U.S. together with the monetary policy in the EU provided support for RSX. Tired of ultra-low (and sometimes negative) interest rates, investors decided to shop elsewhere. Also, Russia finally had its first capital inflow in 5 years, as money was most likely repatriated in fear of further sanctions. I’ve seen different opinions on why exactly Russia suddenly had a capital inflow despite no positive changes in economy, investment climate, etc., and I stick to my own view of repatriation of the capital. I must admit that you won’t get a firm data on this topic, so any conclusions imply some sort of speculation. The next thing is that the Russian government was willing to accept a lower ruble-denominated oil price. The ruble-denominated price is critical for the Russian budget, which is seriously dependent on oil income. However, the USD/RUB quote is followed by the majority of population during spikes. An increasing ruble is perceived as a sign of strength of the country, and the declining ruble is a sign of weakness. Therefore, everyone gets nervous when ruble devalues further. So, there is a kind of political “stop” to the rate of ruble’s devaluation even if it hurts the budget and the economy to some extent. When I was writing my initial article on RSX, the ruble-denominated price of oil was 3453 per barrel. Now, it is just 3052 per barrel. This is an 11% decline and I expect that the ruble-denominated price of oil will normalize closer to at least 3200 level. Ultimately, it is a bet on oil price direction Here are RSX top 15 holdings . Stock Weight Sector Surgutneftegaz ( OTCPK:SGTPY ) 8.69% Oil & Gas Sberbank ( OTCPK:SBRCY ) 8.22% Financial Gazprom ( OTCQX:GZPFY ) 8.04% Oil & Gas Magnit 7.97% Services LUKOIL ( OTC:LUKFY ) 7.89% Oil & Gas Novatek 5.83% Oil & Gas Tatneft ( OTCPK:OAOFY ) 5.47% Oil & Gas VTB Bank 4.93% Financial Rosneft ( OTC:RNFTF ) 4.83% Oil & Gas Transneft 4.00% Oil & Gas Mobile Tele Systems 3.94% Technology Uralkali 2.25% Basic Materials Yandex (NASDAQ: YNDX ) 2.21% Technology Polyus Gold ( OTCPK:OPYGY ) 2.20% Basic Materials Polymetal ( OTCPK:AUCOY ) 2.19% Basic Materials As you can see, most companies directly depend on oil and gas prices. The devaluation of the ruble gave them cost advantage, but at the same time they remain vulnerable to additional oil price downside. Financial and services companies will continue to feel pressure from the slowing economy. In my view, the more oil stays around $50, the worse the Russian economy will get. The head of VTB Mr. Kostin even made a remark ( Google translate link ) during the forum “Russia calling” that it made no sense to lend to small and medium businesses in the country. Of course he got bad media for this call, but truth is truth no matter how ugly it is – new businesses need growth prospects in order to survive, and these prospects are muted in the current environment. I believe that pressure on all non-energy and materials sectors will mount if oil prices stay where they are. RSX is mostly a bet on the energy sector, but the performance of other companies does matter as well. GDP continues to shrink along with domestic demand. Reserves has been stable in recent months, but the budget deficit will start eating the country’s reserves unless there is an increase in the price of oil. At the end, it looks like everything will mostly depend on the price of oil. If you believe in the oil price upside, you should buy RSX. If you, like me, think that there will be additional downside in the price of oil, then RSX is a short candidate. I think that currently neither investors nor economy is ready for Brent prices of about $40 per barrel. If we see this, RSX will likely retest its last-year lows. Scalper1 News
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