Russia’s financial meltdown, sanctions and Syria
The world witnessed Black Monday in Moscow last week as Russian stock markets plunged 8 per cent and the rouble tanked 5 per cent against the US dollar in a single session. The reason? Financial panic after the US tightened financial sanctions on Vladimir Putin’s closest cronies to punish the Kremlin for its intervention in the 2016 Presidential election, the poisoning of a former MI6 double-agent in Salisbury and his support for Syria’s Baathist regime, which murdered civilians yet again with a chemical bomb attack in Douma.
It was surreal to see Sberbank (Russia’s biggest bank, in existence since the reign of Tsar Alexander II in the 1860s) plunge 17 per cent and baby oligarch Oleg Deripaska’s Rusal fall 50 per cent in a single session. Borrowing costs for Russian companies will now rise in the global capital markets. Foreign markets will shut down for Russian exporters. Despite $72 Brent crude, Russia runs a tangible risk of a double dip recession. This was the biggest trauma for Russian equities since Putin’s 2014 annexation of Crimea from Ukraine. The Micex index, among the lowest valued major emerging market indices on the planet, fell below its 200-day moving point average. After all Russia traded at 6.4 times earnings before the plunge, cheaper than Pakistan and Nigeria.
Putin’s geopolitical brinkmanship has only bought Russia financial disaster, as the destruction of Yukos, the invasion of Georgia and Ukraine, the use of Gazprom as a foreign policy tool and the Syrian military intervention attests. Britain, France, Germany and the US have acted against the Kremlin in unison in the Sergei Skripal spy poisoning case. While oil prices are near 3-year highs (oil and gas is 25 per cent of the Russian GDP, making the Kremlin a petrocurrency state), tighter sanctions could still trigger the highest capital flight since the end of the USSR and tip a fragile economy into recession. Russian sovereign dollar debt has widened to 200 basis points above Uncle Sam debt, immediate post Brexit levels, when oil prices were in free fall. Geopolitical risk has now widened. Russia’s credit default swaps. Putinomics has failed Russia. If the Tsar’s soldiers voted with their feet (a Lenin quote), Putin’s creditors voted with their Bloomberg screen.
Aluminium has soared more than 12 per cent on the London Metal Exchange as Deripaska’s Rusal supplies 6 per cent of global supplies and has now been shut out of US markets and US dollar funding sources. Rusal supplied more than a third of the inventories on the LME, which will now reject its metal. After all, Rusal is the world’s largest producer of aluminium outside China, has lost 50 per cent of its value in Hong Kong and will no longer be able to deliver aluminium on either London’s LME or Chicago’s CME. My call? Stay long aluminium as prices have to rise higher to meet the demand of international trading houses who can no longer buy from Rusal. Deripaska will have to transfer his smelters to offshore allies, possibly via Kremlin blessed deals with China. Rusal’s collapse could deal a political blow to the Putin regime since it employs 60,000 people and generates 16 per cent of Russia’s export earnings. A debt restructuring of Rusal is also inevitable.
Credit default swaps (CDS) do not lie. Russia’s sovereign CDS has blown out 40 basis points last week to 165 after Trump’s warning for Putin to “get ready” for US missile attack on Syria. Both Trump and Putin are playing a game of geopolitical chicken in the Middle East whose endgame could well poison international relations forever.
The US, British and French attack on Syria’s chemical weapon facilities was precise and not a prelude to regime change. The best geopolitical hedge for now is oil and gas shares on Wall Street, undervalued relative to crude prices. I would avoid BP since it owns 19 per cent of the Kremlin’s energy colossus Rosneft. However, Total benefits from the Saudi Crown Prince’s recent visit to the Élysée Palace and the $9 billion deal with Aramco. It is almost certain that Trump will roll back or scrap the Great Power nuclear deal with Iran in May. This means a protracted supply shock premium in the oil market even as Bank Rossiya halts its rate cutting programme. My call to buy the Canadian dollar at 1.30 for a 1.25 target has thus been vindicated by world events. The loonie is a classic petrocurrency. The ideal FX trade if the Syria military crisis escalates? Long Norwegian kroner and short the Turkish lira.