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Chaos Mounts in Russia. Here's What Investors Can Do…

Companies / Russia Dec 19, 2014 - 06:25 AM GMT

By: Money_Morning

Companies

Dr. Kent Moors writes: The collapse in oil prices has exposed some vulnerable economies. All of them are dependent upon crude export sales to maintain even the appearance of a national budget.

As you might expect, every member of OPEC falls into this group, although Saudi Arabia, Kuwait, and the United Arab Emirates have sufficient reserves that will allow them to carry sizable budget deficits for some time.


However, Venezuela, Iran, and Nigeria are in a real bind. Each needs oil to be over $100 a barrel to keep it all afloat. That's tough to finesse when oil is selling for less than $60 a barrel.

Today, Caracas is on the verge of defaulting (again) on its sovereign debt, Tehran may need to reintroduce rationing, while Abuja is fighting an incendiary civil war against Islamist fundamentalists in the north.

Yet these nightmares are hardly limited to OPEC. Other export-dependent producers are likewise taking it on the chin.

And at the top of this list is Russia, which has now come completely off the rails…

Low Oil Prices Have the Kremlin on the Back Foot

As it stands, Moscow relies on the taxation of oil and natural gas exports for at least 50% of its central budget. An additional amount is garnered from proceeds indirectly dependent upon both the internal and external trade in oil.

The problem is the current budget planning in the Kremlin had been based on a price of at least $85 a barrel for the Urals Export Blend, Russia's only genuine graded crude. As an inferior grade compared to the Brent benchmark, it trades at discount.

That means Brent needs to trade at more than $90 to arrive at a price that can make Moscow's central budget work. This scenario is hardly likely with Brent trading below $70 these days.

So the Kremlin has been scrambling. The combination of low oil prices and increasingly painful Western sanctions over Ukraine has put a major strain on the Russian economy.

As it all unfolded, first it was met with bravado. But that didn't last long.

With the Ministry of Finance (MinFin) already indicating a recession would hit in the first quarter of next year, the contraction in oil has made the situation even worse and the responses more serious.

Second, President Vladimir Putin announced cuts on the expenditure side in the budget. Most of these remain to be identified, but they will certainly hurt those who can least afford it- pensioners, those needing medical care, employees of companies reliant upon government contracts, and the local authorities that have been laboring under heavy expenses to provide for well over 200,000 refugees from Eastern Ukraine.

You see, the Russian government still operates much of its economy as "extra budgetary." This means essential services, infrastructure, even the production of necessary materials remains off the books. A strain in finance, therefore, has a magnifying effect beyond the "official" figures.

Then came the most serious sign the wheels were beginning to fall off in Moscow.

The Ruble's Race to the Bottom

In the wee, small hours of the morning of December 15, the Russian Central Bank (RCB) met and raised the primary interest rate to 17%, up from a 10.5% rate introduced just a few weeks ago.

The reason was simple. After allowing the ruble to float, the RCB had seen a significant weakening in the currency's buying power. The ruble had declined by some 50% and was trading at a record low 65 to the dollar. Commentators started to compare the situation to 1998 – when Moscow defaulted on its debt and the ruble plunged.

Now, inflation is accelerating and officials are privately estimating that capital flight will exceed $135 billion a year.

As it stands, the Russian rate jump has failed to stop the ruble's plunge.

The ruble dropped all the way to 80.10 per dollar this morning, marking a record low.  It's become so volatile, retail currency trading platform FXCM halted ruble trading this morning, saying it expects major traders of the currency to stop pricing the ruble this week in anticipation of capital controls.

The costs of this plunge will be staggering in terms of economic retrenchment, interbank credit freezes, rising unemployment, and the reversal of new business development.

And some of my contacts in Europe are already expressing concerns that the sudden Russian crisis may have an adverse impact on economies farther to the west.

This can become dangerous, both for the domestic cohesiveness of Russia and the security of its immediate neighbors.

The oil slide is beginning to have consequences that have an impact well beyond the trading pits.

A Very Lucrative Opportunity. But There's a Catch…

However, there is a way to profit from a declining Russian economy. I have mentioned this investment option here before. But keep in mind, this trade isn't for everybody. It's a move that requires considerable attention. This is not something you buy and then go on vacation.

It's the Direxion Daily Russia Bear 3X ETF (NYSE Arca: RUSS), an exchange-traded fund that pays roughly three times the decline in the Russian stock market.  Through the close of trade on Monday, it was up 177.9% over the past month and 81.4% for the most recent week.

Again, this is a trade that moves quickly. For example, it gained 35.6% on Monday alone. Yet, after hours following the RCB rate move, it quickly retreated by 9%. That volatility continued into this morning as RUSS gained 37% in early trade before pulling back.

For those willing to take a risk, this is the most direct way to profit from a Russian decline. It also has large trading volume, making it a very liquid trade.

But remember, you need to monitor this trade very carefully. If the Russian market recovers, RUSS shifts into reverse, giving you a loss equal to three times the Russian gain.

Source : http://moneymorning.com/2014/12/18/chaos-mounts-in-russia-heres-what-to-do/

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