Ukraine likely to present buying opportunities, strategists say

Although it could have severe effects on Russian ruble, they're betting the crisis will be settled peaceably

Mar 7, 2014 @ 12:20 pm

By Carl O'Donnell

Ukraine, Russia, Europe, energy, markets
+ Zoom

The impact on financial markets of the political turmoil in Ukraine has extended far beyond the Crimean Peninsula, but strategists say that while investment risk may be elevated, they're betting on a smooth resolution to the crisis.

In fact, it may offer opportunities to buy assets cheap.

Huge capital outflows hit the ruble and Russian stocks hard this week as the crisis reached a breaking point. European stocks, guilty by association, also took big hits, as did base metals, which suffered “mainly because of a fear that a broader regional conflict would reduce global demand,” said Sameer Samana, a senior international strategist at Wells Fargo Advisors.

On the flip side, holders of agricultural commodities, oil, and natural gas futures saw gains as investors feared a global supply crunch, he said.

“It's hard to predict how all this will unfold,” said Dennis Hudachek, a senior ETF analyst for ETF.com. “This may be a time for investors to re-evaluate their exposure to Russia.”

One possible play is to exploit cheap Russian equities prices by adding exposure to Russia's big state-owned oil companies, such as Gazprom and Lukoil, said Barry Fennell, a senior research analyst at Lipper Corp.

“This would involve taking on a lot of volatility and risk,” Mr. Fennell warned. “You would have to believe that the price of oil would continue to hover around $100 to $105, as it has been doing for a few months.”

The easiest approach would be to buy into ETFs that track Russian equities. By far the largest is Market Vectors Russia ETF (RSX), which has about $820 million in assets under management, according to ETF.com. Another alternative would be the $262 million iShares MSCI Russia Capped ETF (ERUS), which offers exposure strictly to assets traded on Russian exchanges, Mr. Hudachek said.

Both ETFs are heavily exposed to oil and natural gas producers, he said. For example, more than 52% of ERUS is invested in energy, according to ETF.com.

This strategy comes with one big, looming risk: a trade embargo could kill Russia's ability to export to the west, crippling the profitability of energy firms, Mr. Fennell said. But Mr. Samana said he didn't think that was likely, as Europe is heavily reliant on Russian energy.

A more likely downside would be a continued slide of the ruble, which could hack away at any equities gains, Mr. Samana said. In the longer term, there is also the probability that Europe will gradually wean itself off of Russian natural gas, perhaps by increasing imports from the United States or elsewhere, he added.

“I could see this as a cheap market geared toward energy prices, which are fairly resilient,” Mr. Samana said. “The problem is that now more than ever, it is easy for investors to move to another energy-producing nation if something goes wrong, driving down the ruble.”

Another approach would be to buy spot assets that have been unfairly pressured by the crisis and wait for them to rebound, Mr. Samana said. Copper, for example, plunged 1% on Monday, in tandem with other base metals. Much of that decline was based on tail-risk fears of a serious global conflict, which have since subsided, he said. Copper has since recovered its Monday's loss and more.

A similar dynamic is playing out in Polish equities. A strong performer in recent years, buoyed by a growing relationship with the European Union, Poland's nearly 6% drop in equity prices on Monday was mainly a result of guilt by association, Mr. Samana said. So far the index has seen a partial recovery of about 2.5%, according to MSCI data.

For the typical adviser, this spate of geopolitical strife does not justify a hurried reshuffling of international investments, Mr. Hudachek said. Assuming a peaceable resolution in Ukraine, the major driver of Russian and Eastern European asset performance will continue to be identical to that of other emerging markets: the pace of interest rate normalization in developed countries, Mr. Fennell said.

On the other hand, Mr. Hudachek said, “It is certainly possible something fundamental could happen that would severely affect the Russian economy — and that would be a game-changer.”

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