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#15 - JRL 7250
OPINION: Yukos and the Kremlin -- Clearly Chaotic
Contributed by Roland Nash, Chief Strategist, Renaissance Capital

MOSCOW, July 15 /Prime-TASS/ -- At last count, there were no fewer than 14 different theories explaining why YUKOS is being bullied by the Kremlin. These range from a campaign by the hegemonic Petersburg-FSB clan to take over from the barrow boys of the nineties, to a calculated ploy by Khodorkovsky to acquire Gazprom on the cheap. Each claims to be the definitive inside track, and each is laced with prospective doom (I will resist the temptation to spell out all 14 theories, mainly because the Economist's Gideon Lichfield has already

produced such a stylish taxonomy).

Twelve days on, and despite considerable effort, I can honestly say that I have heard no comprehensive explanation of the convoluted politics behind the arrest of the miserable Platon Lebedev. I am, however, quite certain that the market is doing no better. Not since we seriously considered employing the outside services of a Harley Street doctor to monitor the rumors of Yeltsin's health has the market moved on such tangentially connected analysis as, for instance, the time that Russian law permits a charged suspect to be held before trial. (Answer -- 18 months, as long as the charge carries a potential sentence of at least two years. Lebedev, on the very big 'if' of conviction, faces five to ten years.)

The reaction of a market in the middle of a powerful bull run to the sudden explosion of uncertainty is illuminating. The international investor community appears to break down into two camps. On one side are the inveterate Russian bulls who, quite rightly, point to a booming economy and are prepared to ignore the political noise to buy YUKOS 20% cheaper than they could a fortnight ago. On the other, are the hardened Russia cynics who, with equal validity, ask how it is possible for assets to trade with little discount to developed market peers when property 'rights' are seemingly at the whim of the state, and take profits accordingly.

For better or worse, however, the views of a confused international community will matter little in the face of the actions of an equally confused domestic investor base. For most of the last three years, market direction has been determined by the oil-inspired demand of Russia's oligarchs for cheap assets. This has been particularly true in the last six months when negative real interest rates have catalyzed new waves of enthusiasm for equity. Whether the current dip is a temporary blip in a massive bull run or something longer term will depend on whether or not the government's scare tactics persuade Russians to once again leave their earnings offshore, at least until the outcome of the elections is clearer.

There are three key leading indicators of the resumption of capital flight. The first is the ruble, which the Central Bank has long wanted to see weaker and will therefore use the first opportunity of declining demand to allow depreciation. So far, in the last fortnight, the ruble has depreciated from 30.3 to 30.5 against the dollar, with the six month NDF rising from 30.5 to 31.0. Second is the yields on corporate debt, which tend to be highly susceptible to changes in domestic liquidity. Corporate yields on two-year ruble Gazprom have risen from 9% to 11%, and yesterday the corporate debt market suffered one of its worst one-day falls ever. Finally, and most directly, is the change in CBR reserves. Announced every Thursday as of the previous Friday, the first relevant number will appear this week. So far this year, reserves have risen by a quite extraordinary average of USD500 million per week. If that trend shows a marked reversal, then the current market weakness is likely to last.

While perhaps more wary than most when the news first broke, I was still

persuaded on Monday to confidently predict that the worst of the headlines was already behind us. My prediction was based on experience that the lack of clarity surrounding Russian politics invariably incentivizes a rapid escalation of sensationalism, which tends to substantially overshoot reality. On Tuesday, however, Presidential Advisor, Andrei Illarionov comprehensively proved me wrong by raising the specter of civil war, which I can confidently predict would not be good for the equity market. Fortunately, Mr. Illarionov, while a superb economist, has a track record of generating the most bizarre of headlines. Nevertheless, that such news is still plausible in otherwise sensible newspapers strongly suggests that the worst of the uncertainty is not behind us.

A sometimes-wise trader, recognizing that trading patterns were confusing to an economist, once provided me with a set of trading maxims. Top of the list was that 'Uncertainty Breeds Contempt'. With 14 rumored reasons for a public arrest, Russian markets currently qualify for uncertain. Following a combination of the surprisingly aggressive response from Group Menatep lawyers yesterday, the spread of the oligarch investigations to Deripaska, and the first signs that Russian money is taking a step back, there seems little hope that calm will return any time soon. While we remain firmly convinced that this whole mess should be viewed strictly through the prism of the forthcoming elections, and that the return of electoral order will result in a classic buying opportunity, there appears more reason for downside in the near term.

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