A Capital Offensive

The RTS ended the week down only 3.4% because of the 22% rise on Friday. MICEX rose 28% on Friday and ended the week also down 3.4%. Trading on Friday was very confused with the bourses opening and closing almost with the regularity of a cuckoo clock. The massive injection of capital into the financial system and other market supportive measures have helped avoid an even worse crisis.

The oils, Gazprom and the two state banks led the rally on Friday. The state company shares were in particular demand after the government said it may use some savings to buy shares. The electricity sector shares were the main laggards over the week, along with regional telecoms and metals

A short-term target of close to 1,500 for the RTS is possible as the government pushes its investment friendly credentials and as the price of oil looks to have found support around the $90 p/bbl level. But how the global markets trade this week will be critical for sentiment. The dollar looks set for further weakness and that will help support the Ruble and commodities. A December rally, if investors can look more optimistically into 2009, is the major hope for a better year-end target.

Trade talks with the EU, suspended after Russia’s actions in Georgia, may resume as early as next month according to the French PM. The fact that potential damage to the important Russia-EU relationship appears to have been avoided is also a positive for investment sentiment.

The main drivers of the market beyond the current relief rally and hoped for closing of the gap with the MSCI GEM Index will be events in the global financial markets and global economic indicators. But the most important driver for Russian asset values will be the trend in the price of oil. A major comfort factor for Russian investors is the fact that countries like Saudi Arabia need just as high an oil price average because of their huge social and capital spending programmes.

Global markets ended one of their most volatile ever weeks almost flat. The FT All-World Index increased 0.2%, the EuroStoxx dropped 1.0% and in the US the Dow ended the week down 0.3% while the S&P ended up 0.3%. Emerging markets rose 10% on Friday to end the five days with a loss of 1.2%.

Emerging market currencies also staged a strong rally on Friday and that trend looks likely to extend further as the outlook for the US dollar looks weak. The Yen took a hit with the unwinding of the carry-trade but will probably recover.

Oil (WTI) climbed back above the $100 p/bbl level as the dollar declined and confidence grew that the actions of Central Banks may avoid a major recession in the world. Nigerian militants caused a further loss of 280,000 bbl/d to bring the amount now shut-in to 1.0 million barrels. The price is unlikely to push much further ahead, because of economic concerns, but traders are equally unlikely to allow the price test the mid $80 p/bbl level again too quickly.

The price of gold jumped this week as investors looked for havens. Most other metals rose on Friday, albeit nickel continues to lag others. The dollar and confidence over the global economy in 2009 will dictate the trends this week.

Agriculture commodities rose with the euphoria on Friday but the outlook is for further weakness this week as harvest reports improve.

Russia funds took in new money for the first time since July 1st last week and bucked the negative trend in other emerging market funds. This despite the major collapse in prices and the market closures. Russia funds are no longer the worst BRIC country for 2nd half flows; India funds are.

A short-term target of 1,500 for the RTS is not unreasonable. The rally on Friday, as the government mirrored the actions of others around the world by making available billions of dollars to the financial markets, came as a huge relief to investors. That momentum will likely carry through to the opening today as many stocks that fell over the last week will play catch up with those that led the rally on Friday. A near term target of 1,500 for the RTS is a not unrealistic expectation. But clearly there is a lot of confusion in all markets, Russia included, and are by no means clear of trouble. The rally on Friday was caused by a mixture of relief, exuberance and, in particular, short-covering. All three of those factors will end in the next few days and then it will be time to survey the wreckage and assess prospects for future growth. The picture is not pretty, but sobering. As with previous major market crisis, we may now see a lengthy period of reduced market activity as investors and the banking industry adjust to new realities. In many ways it will be like the aftermath of a bereavement. Inevitably there will be more casualties. In stock terms, the focus is likely to remain on the state companies and the most liquid names. 2nd tiers will remain in the background. But if momentum, or even stability, can be maintained then we should see investor interest extending to sectors/stocks, such as the electricity and regional telecoms, that were badly battered early in the week but have not yet participated in the recovery.

Government is expected to push an investment friendly agenda. The RTS at 1,500 brings the index back to the level of two weeks ago when the downward move accelerated with rumours of problems with US financial institutions, with the falling price of oil and, latterly, the forced margin selling on the domestic market. The third of those reasons has probably now been sorted with the actions initiated by the government and market regulator. There maybe some further selling as under-pressure investors, or simply the nervous, take advantage of the rally to sell, But that pressure should be slight and government funding is in place to mop it up. The more proactive stance taken by the President and his senior ministers to push a more investor friendly agenda, and to address the concerns raised by the Mechel and Georgia events, is expected to continue. The legacy of summer events will not be removed quickly but credibility should rebuild slowly. The announcement by the French Prime Minister at the weekend that trade talks with the EU may resume as early as next month shows that only minor damage has been caused to the important Russia-EU relationship. The RTS has under-performed the MSCI GEM by 15% since the start of the summer, i.e. that is mainly the cost of Mechel and Georgia; a closing of that gap is what the re-focusing on the investor friendly agenda promised by the Medvedev government may produce.

This Week

Global financial markets and oil will drive the market to year-end. Beyond the relief rally, the short-covering and the hoped for gap-closing with the MSCI GEM Index, the main driver of the market to the end of the year will be the unfolding events in the global financial markets and economy and especially the trend in the price of oil. Both of those factors will be to the forefront of global investor interest this week. After the Fed’s major offensive against the crisis with over $700 bln to buy out bad debts, the Administration now has to persuade Congress to back the deal. That will not be easy but in the sense that there is no choice, it should be passed. But the price to be paid will be greater market regulation and some significant changes in the way the investment industry goes about its business. That will be the backdrop to likely very slow and ultra cautious markets to the end of the year. A December rally is the major hope, i.e. if economic indicators don’t point to major recession in 2009. This week’s economic calendar in the US is quite light with the most important reports being Tuesday’s existing home sales update. On Wednesday there will be a durable good orders report, on Thursday the focus will be on new home sales and on Friday the big numbers will be the final 2nd Qtr GDP report and revised corporate profits for the 2nd Qtr. The outlook for the dollar is for weakness because of the scale of the US bailout and the risk it poses to stability in the economy. Traders are likely to remain wary of the currency until the situation stabilizes. That should provide support for commodities, best especially for gold and for oil. Base metals are less attractive given the uncertainty over demand and agriculture commodities are not expected to hold onto Friday’s “feel good” gains. The price of oil successfully pulled back from the threat of falling below $80 p/bbl (Urals) and should stay at least in the $90’s p/bbl over the coming week.

Trading Last Week

RTS ended the week down 3.4% despite Friday’s 22% gain. By now almost every cliché available has been used to describe the action in Russian shares last week. Scary and confused are the too simplest and the most accurate. Bottom line is that the pace of growth in the “front office” was not matched by that in the “back office” and given the exceptional circumstances that hit the market over the past two weeks, i.e. an escalation in forced selling and margin calls, the inadequate system broke down. KIT Finance’s inability to settle some obligations on Tuesday was the proverbial last straw. But, no doubt, the government and regulators took exactly the right action and the rest, as they say, is history. At least for now. Friday’s equally confused session saw the local bourses open and close at the regularity of a cuckoo clock. But in the end the RTS was up 22.4% and MICEX an even more impressive 28.7% higher. But over the week both indices were still lower, reflecting the scale of the carnage on Monday and Tuesday. Both indices ended the week down 3.4% with the RTS now off 48% since the mid May high and MICEX down 32% over the same period. The mid cap RTS-2 Index, although mainly ignored in terms of actual business, rose 2.6% on Friday and ended the week down 6.8%.

Oils and banks led the rally. In sector terms the main action was in the oils and banks. Not surprising given the external drivers of crude pricing and the action in the global banks. The RTS Oil and Gas Index rose 28% on Friday and the Financials Index gained 20.4%. Over the week they former ended up 0.9% while the latter ended down 5.8%. There was relatively little movement in other sectors on Friday but of course all fell heavily on Monday and Tuesday. Because of the failure to bounce on Friday the Electricity sector index close the week off 18% while Telecoms and Metals were off 12% each. The table of best and worst performing shares over the past five days is at the end of this note. Not surprisingly, given that most interest through Friday was in the biggest stocks, especially oils and banks that shares such as VTB, Rosneft and Gazprom are in the top half of the table while the bottom half is packed with electricity and real estate names.

The shares with the best bounce on Friday included:

Sistema+47.1%(+9% for the week)

Surgutneftegaz+44.2%(+7% )

Sberbank+41.9%(-5% )

VTB+39.1%(+17% )

Gazprom+35.3%(+2% )

Rosneft+34.0%(+1% )

Novatek+34.0%(-9% )

Sistema Hals +32.8%(-46% )

PIK Group+31.2%(-25% )

Transneft Pref+31.0%(-15% )

Evraz+30.0%(-2% )

AFI Development+29.7%(-25% )

LUKoil+27.3%(+6% )

Highland Gold+23.8%(-16% )

Comstar+18.0%(-3% )

Source: RTS, Bloomberg

Global markets ended a very volatile week flat. Global markets (FT All-World, $) ended one of the most volatile weeks ever almost flat, i.e. with a gain of 0.2%. The measure rose over 6% on Friday and 8% through Thursday and Friday. That was the best two-day gain since 1970. The US markets mirrored that with two-day gains that matched that last seen only after the October 1987 crash. On Friday the S&P 500 Index rose 4.3% while the Dow Industrial Index rose almost 1,000 points from the low point on Thursday to the close on Friday. The rally was led by the Financial sector, rising 11% on Friday after gaining 12% on Thursday. The volume of shares transacted was a record three billion, or more than double the average daily turnover. Over the five days the net move was a loss of 0.3% for the Dow and a gain of 0.3% for the S&P 500. Europe’s EuroStoxx Index rose over 8% on Friday to reduce the weekly loss to 1.0%. The MSCI Emerging Markets Index rose 10% on Friday to bring the weekly move down to a loss of 1.2%. Apart from Russia’s big move on Friday, the Brazilian Bovespa jumped 9.6% and the Chinese CSI 300 Index gained 9.3%.

Emerging market currencies staged a rally. There was just as much confusion in the currency markets as in other asset classes last week. The dollar weakened after the news of the Lehman Brothers closure and the bail-out of AIG. But the expected collapse did not occur and one reason that traders have stated is because US investors were unwinding positions globally and repatriating the proceeds. That would have accounted for the relatively modest drop in the value of the dollar and keep alive the fear that we see the currency fall much further this coming week. Over the week the Dollar fell 0.4% against the euro to end the week at $1.437 and it fell 1.2% against Sterling. The weakest currency was the yen as investors continued to unwind the Yen carry-trade as they sold out of other assets bought with the cheap yen. Emerging market currencies also staged a rebound as the asset class returned to favour. Brazil's real rose 3.5% on Friday after it hit a one year low against the dollar mid week and that was more or less how the Ruble traded. It closed a very volatile week with a bounce of Friday as traders bought the currency to settle equity trades and buy the market. Over the five days the ruble rose 0.8% against the dollar to $25.43.

Commodities

Oil over $100 p/bbl with the dollar, hurricanes and Nigeria. Oil started the week by falling more than $10 p/bbl as traders feared a collapse in the global economy and a destruction of demand. But from midweek, four factors combined to pull the price of oil higher, with WTI ending the period just above the $100 p/bbl level. The effect of several destructive hurricanes in the Gulf of Mexico was seen in the weekly inventory report from the US Energy dept. Its midweek report showed a drop in the stocks of both gasoline and of crude (by more than 6 mln barrels). That stalled the price collapse of Monday and Tuesday. Then came news of an escalation in attacks against oil facilities in Nigeria. Industry analysts estimated that the volume of oil shutdown amounts to 280,000 barrels of daily capacity, which brings the total amount of “lost” Nigerian production to about 1 million bbl/d. The weakening of the dollar from Thursday had a direct impact on all commodities and pushed prices still higher. The big spurt came on Friday with general optimism that the Central Bank actions may avert the feared global recession. The price of WTI for October delivery rose $6.6 p/bbl – adding to the biggest three day rally for oil in almost ten years – to close at $104.55 p/bbl. The equivalent Bret contract rose $4.42 p/bbl on Friday to end at $99.61 p/bbl while Urals last traded at $97.15 p/bbl. Over the five days the price of WTI rose 3.3% (8.9% year to date) and Brent gained 2.3% (6.4% year to date).

Gold jumped with financial market uncertainty.The price of base metals rose joined the euphoria on Friday, partly because of the dollar decline, partly because of the prevailing optimism that the global economy may be saved from a recession, or at least a deep one, and partly because traders rushed to close open short positions. Copper rose 4.6% through the session albeit over the week it ended 1.0% lower. Zinc also recorded a big jump (+3.7%) but still ended the five days lower by 5.6%. Since January 1st, zinc is off 64%. Nickel continues to be the main laggard in recent weeks and although it managed a modest 1.3% rise on Friday it still ended the week down 12% at $16,843 per tonne. That is down over one-third from the start of the summer. Gold jumped 11% on Wednesday as investors looked for safety in the midst of the market mayhem, its best one day gain since 1980. The price pulled back on Friday as investors focused on equities and other commodities but over the five days the price was up 13.1% at $869 per ounce. Silver also recocorded a strong week with a five-day gain of 15.6%.