After a relaxing break in the South of France, I’ve returned to see my portfolio gratifyingly boosted by recent contrarian calls on the dollar (short Euro), equities (long financials and pharma) and commodities (short oil and copper). The CRB index has just had its worst 4 week period in 50 years, losing 16% as the speculative bubble I’ve described many times on this blog popped with a vengeance. Nickel is down 46% from the highs, Wheat 41%, and Natural Gas 40%; copper and oil have just entered bear territory, both down 20% so far but copper may easily halve from the peak (see Copper and China post). The flip side of the commodity slump has been the resurgence in the unloved dollar; I suggested on 27 July in Has the Dollar Bottomed? that a major reversal was imminent, but its magnitude and speed has been surprisingly dramatic; last week was the best for the dollar since the Euro’s inception in 1999. In these markets, records tumble by the day. Also as forecast in previous posts, emerging markets are underperforming developed (with Russia and China particularly weak while India is bottoming) and Japan is the weakest of the developed markets. Crucially in the US, policy responses to the credit crunch are finally gaining traction just as Europe and Asia slow markedly. The combination of a cheap currency, a positive yield curve, and the recapitalization of bank balance sheets are now speeding the recovery process for US equities. Overall, I see no reason as yet to change investment tack, although I’m closing most of my oil short until the implications of the Russian invasion of Georgia are clear. While I was in France, much local media attention focused on the outrageous sum of $750m paid by a Russian oligarch for a prime mansion on the Cote d’Azur, in a macho bidding war with his equally spendthrift Moscow peers, whose idea of sophisticated entertainment is burning bundles of 500 Euro notes in front of the hired staff (not all of whom work on their feet). Apart from reflecting the corrupt pillage of the Soviet resource economy by a handful of well-placed insiders in the 1990’s, this is the kind of grotesque financial excess that has previously marked major turning points in economic history. Indeed, the last time Russian buyers displayed such shameless decadence in France was among the aristocratic elite just before the fall of the Tsar nearly a century ago. Meanwhile, Putin (reputed to be an offshore billionaire himself by some sources; political power in Russia guarantees you serious purchasing power) is encouraging loose talk of basing Russian bombers in Cuba, and sending the tax police heavies to shake down any corporate that incurs his wrath Yukos style. It all smacks of reckless hubris. A commodity crash would have dire implications for the dysfunctional Russian economy, beset by demographic decline, low productivity, 15% inflation and a fragile credit fuelled consumer boom that is vulnerable to a reversal in commodity export prices. I have been bearish of the Russian market for some time (RTS is down 25% since 1 July) given the arbitrary lawlessness that makes long-term investing there a spin of the roulette wheel.

The increasingly belligerent attitude to foreign investors, immigrants, and neighbouring countries, combined with the endemic corruption and decay now affecting every state institution under the Putin regime, may soon make Russia a bigger geopolitical risk factor for global investors than Iran. Despite the military posturing, army conscripts remain an emaciated drug addled rabble, the defence industry is largely a shambles, and the rusting nuclear deterrent is becoming more of a danger to Russians than to any adversary. Russia is still that Potemkin village that flatters to deceive. In particular, the Kremlin is not the monolithic power it appears, but referees a shifting coalition of clans, from energy barons to the security services and regional bureaucrats, whose sometimes violent rivalries have so far remained misunderstood by many naive foreign observers. It’s 10 years since a default crisis in Russia spread shock waves though emerging markets globally. Although the nature of any upheaval will be different this time given the huge foreign reserves now accumulated, the potential for Russia to export chaos along with crude remains high.

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Commodities, Market Commentary