My #1 Pick in Russia, the World’s Most Hated Stock Market

Russia is the market that investors love to hate.

George Soros lost over $1 billion investing in Russia after the Russian government defaulted on its bonds in 1998. When asked about Russia, Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway (BRK-B), harrumphed: “We don’t invest in kleptocracies.” One investor famously declared after the market’s meltdown in 1998: “I’d rather eat nuclear waste than invest in Russia.”

Russia’s image hasn’t improved since. Fifteen years ago, when you heard “mafia,” you thought of the Godfather. Today, you think of a Russian “biznisman.” If India is embodied by a highly educated, dedicated high-tech worker, Russia is the thug you cross the street to avoid. India is Bill Gates. Russia is Scarface.

With Russian President Vladimir Putin annexing Crimea at his whim — and lining tens of thousands of troops along Ukraine’s border as a thinly veiled threat for a future invasion of Ukraine — chances are you feel the same way.

Certainly, you wouldn’t be alone.

Russia: Always a Contrarian Investment

Foreign stock investors pulled $3.2 billion from Russian investment funds in 2013. That’s alongside $63 billion of capital flight from Russia by Russians themselves. The World Bank expects capital outflows to hit $150 billion this year — exceeding the $120 billion in capital flight that Russia saw in 2008 during the global financial crisis.

And with the Russian stock market down 16.90% so far in 2014 — making it the single worst performer among the 44 global stock markets I track on a daily basis at my firm Global Guru Capital — on its face, that looks to be the right bet.

The irony is that buying Russia precisely at the time news is the worst has been one of the most successful investment themes around.

As Bill Browder — once the biggest foreign investor in Russia — put it in 2006, “Russia sucks. But if over time, it sucks a little less, I make money.” Indeed, Browder himself pocketed over $130 million in 2005. That was right before he was banned from re-entering Russia, eventually forcing him to wind up his firm Hermitage Capital a few years ago.

Browder’s statement contains a profound insight.

It’s easy to invest in a sexy biotech Chinese Internet growth story.

It’s hard to invest in countries and companies everyone hates.

In the mid-1990s, Browder realized that if Russian natural resource stocks were trading on 1-2% valuations of their Western counterparts, over the long term, there was only one direction they could go. More importantly, he had the psychological stamina to tough it out during periods of gut-wrenching volatility like this past month.

As a personal example, I bought a Russian oil company Tatneft (now delisted) at $1.50 in September of 1998 — and sold it in a couple of weeks after tripling my money at around $5.00. It later reached a peak of $120 in 2006.

Stomach that kind of volatility and you deserve to get rich.

While Russia will never be as cheap as it was in 1998, it’s certainly as cheap as it has been since then. According to the Financial Times, Russia is trading at about 0.6 times price-to-book value. That’s a 65% discount to the broader MSCI emerging markets index and a greater discount than at the height of the 2008 financial crisis.

If Russia’s actions lead to World War III — right on schedule for the 100th anniversary of the breakout of World War I — then that discount still isn’t enough.

But I’m betting the bad news is already priced in.

“Buy on the Cannons, Sell on the Trumpets”

Coined in 1810, and attributed to London financier Nathan Rothschild, the phrase “buy on the sound of cannons, sell on the sound of trumpets” recommends that the start of a war is a good time to invest in the stock market. Conversely, the end of a war is a good time to sell.

Although no war has broken out in Ukraine, I recommended that subscribers to my Bull Market Alert trading service buy Russian natural gas giant Open Joint Stock Company Gazprom (OGZPY) — the very day after Crimea’s referendum to join Russia on March 17 — was a test of that time-honored investing wisdom.

Here was the investment case as I set it out…

Gazprom is the world’s largest producer of natural gas, and it supplies 30% of Europe’s gas needs. When I recommended it, Gazprom was down almost to 90% from its peak. The stock was trading at a price-to-earnings (P/E) ratio of under 2. The last time Gazprom had been this cheap was at the height of the 2008 financial crisis.

Investing in Russia is also a perfect example of what I call my #1 contrarian indicator. When a country hits the cover of the Economist with a negative story, more often than not, there will be big gains in that country’s stock market. And Russia had made the cover of the Economist with a negative story two out of the last three weeks.

Sure there are plenty of reasons why investing in Gazprom might not work out, I pointed out. Gazprom may be the world’s #1 value play, but it could get even cheaper. If we are at the start of World War III, then all bets are off.

But if we could avoid war, I felt that any relief rally in Russia could generate a quick 30-50% gain in Gazprom.

How has my recommendation done since then?

Much to the delight of my Bull Market Alert subscribers, Gazprom is up 18.09% since then.

And with the company still only trading at a P/E of 2.27, I think there is plenty of upside left.

In case you missed it, I encourage you to read my e-letter column from last week about two strategies you can use to outperform the Oracle of Omaha. I also invite you to comment in the space provided below.

NOTE: Global Guru Capital is a Securities and Exchange Commission-registered investment adviser, and is not affiliated with Eagle Products.