Live it Up!

When the money keeps rolling in you don’t ask how
Think of all the people who are guaranteed a good time now.
~And the Money Kept Rolling In (And Out) from Evita

The Russian equity market continues on its long tear. Just as folks are beginning to wonder when it will end, it seems to be accelerating.

The RTS index is up 95% since I arrived on the Russian market last August. More amazingly, it’s up 35% in the first 35 trading days of 2006. Its bonus season, there’s a palpable euphoria in the air. All is right with the world.

Why? Well, oil is a dominant factor in both the economy and the highly concentrated Russian capital markets. And oil - given demand issues in China and India balanced by supply “issues” in Iran and the middle east - is a legal license to print money.

But statistical studies, run shoddily by myself and more professionally by others in the investment community, show that the correlation between changes in oil prices and market returns are weak at best. The consensus has been that the oil effect has trickled through to the rest of the macro-economy. And to a degree, that certainly is true. Data about currency reserves (the government’s cash hoard is the 5th largest in the world) and Paris Club early debt repayments have lead to upgrades of the country’s sovereign debt, the lowering of the risk premium and sustainable higher valuations.

This makes the direct oil effect much trickier to peg. Current spot oil prices are substantially the same since last August, and have done a good deal of traveling both higher and lower since then. So why the massive advances in an equity index supposedly driven by oil?

I believe that it has more to do with the level of prices rather than the actual price movements. Macroeconomic sensitivity analysis to oil prices shows projected GDP, and personal income, levels in the coming couple of years. All these models assume long-term market oil prices much lower than current prices. Everyday that oil moves in the opposite direction, or even just stays put, is another day where the expectations for the future have to be set just a little bit higher.

So, it seems that as long as the prices stay in a range well above the rosiest long-term price objective (somewhere around $45 per barrel), then the rationale for much higher valuations is supported. By the way, our main oil benchmark hasn’t closed below its 50 day moving average in almost a year.

Of course, it’s a two-way strategy. But, in the meantime, enjoy it while it lasts.