Date: 03/06/22
Author: Kent Moors, Ph.D.
Daily news focuses upon the increasing flow of civilians out of Ukraine following the Russian invasion. Already having risen to more than 1.5 million and rapidly growing, the UN has proclaimed this the most acute European refugee crisis since World War II.
But someplace else there is another stream of people leaving. These are not Ukrainians, they are Russians. And it is an indication of how quickly matters have changed. The situation also brings back some memories.
Starting in the mid-1980s and extending for more than a decade, I was either living in Moscow, had just come back from there to my base of operations in London, or was awaiting a trip back into “Mother Russia.” In those days, Westerners living in the shadow of the Kremlin were allowed travel to Finland for occasional authorized shopping. Most went on to Helsinki but my preferred stop was in the medieval town of Porvoo.
This charming place is in the Finnish region of Uusimaa on the Gulf of Finland and said to be the second oldest location in the country. It is closer to the border with the (then Soviet, now Russian) Republic of Karelia, about halfway between Karelia and Helsinki. Those weekends were a boost to my morale, an opportunity to savor some genuine beer and have a meal at a good restaurant.
Today, there are long lines of autos slowly snaking on the route (the E18) we used from the Russian border into Finland. Only these days the cars are driven by Russians leaving collapsing economic prospects. And according to my personal contacts in that caravan, many are not planning on returning.
As the invasion of Ukraine enters its second week, the situation inside Russia following unprecedented Western sanctions is beginning to unravel. What has ensued in almost the blink of an eye has gone far beyond what anti-Kremlin economic sanctions we could manage in the over four decades that spanned my old Cold War intel career.
The imposition of what was at one point considered an impossible cut from SWIFT (Society for Worldwide Interbank Financial Telecommunication) was introduced by the EU, US, UK, and related neutral Continental states only one week ago. I discussed the historic move and its impact here in CIB last Monday (“After a Financial Nuclear Option, Russia May Have to Resort to a ‘Matty,” Classified Intelligence Brief, February 28, 2022).
The decision effectively cut Russia from access to interbank connections essential for its global trade. Combined with the previous imposition of sanctions preventing access to foreign hard currency it has thrown the Russian domestic currency (the ruble) into a free fall.
It is now becoming difficult to ascertain its actual market value, since the effective purchasing power inside Russia is clouded by localized price spikes in one direction and frantic government subsidies of selected commodities on the other. Nonetheless, my latest estimate puts it at more than 135 rubles to the dollar at street level. That’s at least a 45 percent decline in effective buying power in less than a month.
As I have noted before, it takes time for economic sanctions to have a real bite. But the combination of historically harsh financial and economic measures has quickly brought us to the point where Russians are concerned.
In Friday’s weekly market review for Sigma Trader and PRISM Profits members, I commented on the impact to your investment prospects, writing that:
Today reminds us how serious geopolitical matters have become. Even an unusually strong jobs report could not make a dent in what the Russian invasion of Ukraine is doing to the markets. The aftermath is spreading.
While the impact is expanding market-wide, it is felt most acutely in the trading of Russian equities. If there were ever a toxic zone for traders, this is it. And it is getting worse by the day.
This afternoon [Friday, March 4], S&P Dow Jones Indices announced that it is removing all stocks domiciled or listed in Russia from the index’s benchmarks. The move, set to occur at open next Wednesday, also removes Russia from the emerging market group and places it aside as a standalone.
The decision also will have a significantly negative knock-on effect on the tradability of Russian companies available only as American Depository Receipts (ADRs) in the US. That amounts to just about all of the major available Russian stocks. These ADRs are the only way to play them on American exchanges. Each ADR represents multiple shares of a Russian domestically traded company and can only be purchased by paying a premium on the local value of the underlying shares.
Conversely on the London Stock Exchange (LSE), the straight stock of Russian primary companies such as Rosneft, Gazprom, Sberbank, Lukoil, VK, Severstal, EN+, Polyus, and others were available for open trade. That is until yesterday [Thursday, March 3].
The LSE suspended these eight, along with 19 others. Many have strong ownership connections to Russian oligarchs having deep ties to Putin. The LSE is reviewing additional Russian stocks that trade as Global Depository Receipts (GDRs). GDRs operate similarly to ADRs in Continental markets.
Russian ADRs in the States are occasionally illiquid anyway but have been taking a huge hit since the Russian invasion began, graphically illustrated by their performance in a yardstick I often use – the current rolling week daily average (adding the most recent closing value, deleting the earliest). There at close yesterday [March 3], Gazprom (OGZPY) was down 79.25 percent, Lukoil LUKOY) down 71.06 percent, while Sberbank (SBRCY) was down 88.26 percent…in five sessions. None of these is trading today and other Russian ADRs have had no trades for several sessions.
The miasma has spread to American Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) specializing in Russian stocks. Most of these have suspended trading and have suffered catastrophic declines. We were able to get Sigma Trader members out of Direxion Daily Russia Bull 2X ETF (RUSL) March 18, 2022 $18 puts last Thursday (February 24) with a hefty 226.15 percent profit. Direxion closed writing new paper to the fund after the close of trade on the same day and the ETF is now closed.
With other access points unavailable, the ETF/ETN market had been the only external play in a rapidly unravelling Russian stock market. But those that still remain have suffered massive losses. Those that have not yet suspended operations will do so in a matter of days.
All of those that had remained a month ago were bull funds, betting on the rise in Russian stocks. Some of these were leveraged, providing a multiple gain on advances in those stocks. Of course, the declines were even greater than the face value loss if the stocks went south. These are now ancient history. The last plays providing a profit were puts on those few ETFs allowing them, as the Sigma move on RUSL.
The Russian stock market, in turn, has been closed for five days as the Bank of Russia (BoR, the country’s central bank) desperately hammers together a massive subsidy plan to avoid a market cratering when it does open. Several elements are already taking shape. These include limiting trading volume, preventing the export of proceeds from sales, and preventing access to hard currency in any transactions.
This last step parallels one already taken by the Kremlin. It is prohibiting foreign investors in Russian companies from leaving the country, effectively preventing any outside source of working capital from accessing what they have put into projects there.
It reminds me of what we were hit with during the [GKO] T-bill default of 1998. Then, we were prohibited from moving money out, were required to hold all proceeds in “S” accounts at designated Moscow banks, and ultimately were allowed to access no more than 8 percent of the value of those accounts.
Other developments have hit since I wrote the above. RUSL is now history. After close of trade on Friday, parent Direxion announced that it has transferred all of the ETFs assets into cash, would cease trading altogether on March 11 (ostensibly to allow those remaining a window to sell shares but at a huge loss), and would liquidate RUSL on March 18.
Then there is the integrity of crude oil sales. Oil and natural gas exports are the life blood of the Russian economy. Both continue but there are signs that some end user countries will be cutting consignments. For that matter, UK port workers have already refused to offload the crude. On the gas side, the Kremlin had counted heavily on opening Nord Stream 2 for additional sales to Europe. That project is now dead.
In the US, there is growing bipartisan support to stop importing Russian crude altogether. It accounts for about 3 percent of daily oil imports and 1 percent of processed oil products. In contrast, some 61 percent of imports into the US comes from Canada. The volume can easily be made up but the cost will be higher. Russian crude is imported at discount due to its higher sulfur content.
Then there is the ability of those in Russia to continue conducting personal commercial transactions. Mastercard, Visa, and PayPal all announced on Saturday that they are suspending all services in Russia. That will move all credit card transactions onto domestic, ruble-denominated bank cards. These can only be serviced by internal banks where reserves are now suspect. Personal contacts had indicated late last week that there were already difficulties in using the domestic cards. That was before the Mastercard/Visa decision.
The prospects of bank runs are developing. While the government has said it would guarantee all ruble-denominated accounts, there is a rising disbelief that it will be able to do so. In any event, Russians I have talked to over the past 72 hours have concluded ability to withdraw personal funds will be subject to limitations.
That has already happened with Russian bank ATMs. There, the lines are long and the ability to make withdrawals is coming under pressure. Most believe they can access funds this week but are worried about the longer term. Even then, stops at multiple ATMs are becoming the norm in an attempt to obtain any funds of consequence.
As of last Monday, nobody was any longer allowed to move more than $10,000 out of the country in any fashion (cash equivalent. market value of physical objects, any bank transfers). By Friday, foreign exchange was being halted at some airports and spot checks indicated border officials were further restricting the movement of hard currency out of the country. It is already illegal to take out rubles in any significant amounts (as if the currency would be of any exchange value anyway).
The sanctions will not bring down the Russian society anytime soon. But it is already becoming a place where living is getting more difficult. Especially, for the new generation used to their Western products and better lifestyle prospects.
The sanctions have also taken on an even more disturbing character. Russian President Vladimir Putin this weekend called them a “declaration of war.”
Meanwhile, matters continue to deteriorate in Moscow. As of this weekend, all three major rating agencies (S&P, Moody’s and Fitch) have cut Russia’s credit rating to junk status. Each agency has increased the likelihood of the country defaulting on payments.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
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