By Alexei Medved, World Money Analyst Since my May column, the Russian market got hit badly. The popular US$ denominated RTS index fell 10.2% from 1489 to 1337. The developing financial crisis in Europe pushed investors into the “risk-off” mode, hence all risky assets were sold. This led to strong selling pressure on the Russian market as it is seen as high beta. A significant decline in the crude oil price also helped investors to justify selling Russian assets. As investors rushed into the perceived (perhaps wrongly so) safety of the US dollar, the USD/rouble exchange rate declined by about 6%, further magnifying the decline in the US$ prices for Russian equities. However, unless one believes that the oil price is headed lower and will stay low for a long time (a very unlikely scenario in our view), this correction could represent a good buying opportunity. We don’t know if the global market correction has bottomed or if continued weakness lay ahead. The Russian market could continue its descent should the global financial crisis persist. Also, don’t overlook the fact that Russian macro economic fundamentals remain strong. Inflation is down to a range of 6%, and GDP growth is projected at 4.9% in 2012. Foreign currency reserves are over US$500 billion, the world’s third largest after China and Japan. And the government debt-to-GDP ratio is under 10%, a welcome difference from highly indebted Western European countries and the USA. The Central Bank of Russia has enough flexibility to react to potential external shocks to the Russian economy, and to support its banking system in a stress scenario. Leveraged play on growth of the Russian economy Today, I will focus on the shares of a prominent Russian bank. Over the last 20 years, it has been transformed from the only savings bank in a country with a centrally planned economy, into a profit oriented institution with a greatly reduced headcount and significantly improved management. It remains majority government owned, but 40% of its equity trades on the Russian exchange and as an ADR on a Western exchange. There are concrete plans for the government to sell a part of its stake, possibly this year. The ADRs declined concurrent with the drop in the general markets, and shows that the market is not focused on the company’s underlying strength. This is a significant and unjustified sell-off, in our view, and represents a good buying opportunity. The bank’s fundamentals are very strong. The company has an extensive branch network in Russia and is funded primarily by customers’ deposits, rather than relying on wholesale funding (borrowing on the interbank market or issuing bonds) which led to problems for some Western banks. The bank is also very profitable. Based on recently published results, its Return on Equity, Return on Assets, and Net Operating Margin are all far superior to major Western banks. Profitable operations continue, with strong growth in lending and deposits. The company has a very strong capital position, with Tier 1 capital figures that compare favourably with major Western banks. The bank agreed to a large acquisition deal that will give it a footprint in a fast growing and profitable market outside Russia. Despite these strong fundamentals, the shares are trading at a mid-single-digit P/E and a low P/BV. These valuations represent a 34% discount to its Global Emerging Market peers and a 30% discount to the shares’ historical average valuations. In summary, this bank is a leveraged play on the Russian economy. If the economy does well, the shares are likely to appreciate significantly. At the same time, being a majority government controlled bank in Russia, should the global crisis deteriorate, and the Russian economy start having difficulties, the company is highly likely to receive support from the government and Russia’s Central Bank. To find out the name of the Russian bank and get the full analysis, as well as access to the WMA archives where you’ll learn about other international investing opportunities, take a 100% risk free test drive of the World Money Analyst. [Alexei Medved was born and raised in Russia and later moved to the West. He received an MBA from Wharton Business School and worked for a major global investment bank, where, from 1989, he developed the East European investment banking business. Since 1992, he has been running an independent business which concentrates on investments in Russia and the CIS.]
By Hard Assets Alliance With a seemingly endless stream of macroeconomic risks coming down the pipeline every day – whether it is the risk of currency devaluation, sovereign debt defaults, bond market collapses, or the ever-present “fiscal cliff” – it’s no wonder that investors have turned to the safety of precious metals. And for good reason: Someone who bought one ounce of gold in July of 2010 would have gotten a return of 32%. Those who bought a year earlier would have raked in 69.2%. And gold investors who bought during the darkest days of the financial crisis would have realized a whopping 77.6% gain. Using exchange-traded funds, like the SPDR Gold Shares (GLD), is a popular way to add gold exposure to one’s portfolio. Since GLD shares are backed by physical gold, many investors are under the impression that they can redeem them for the actual metal at any time… but is that really true? We did some digging into GLD’s 10-K – a comprehensive summary report of a company’s performance that must be submitted annually to the SEC – and found some interesting facts that we believe every GLD investor should know. Here’s a hint: Unless you own more than $16 million worth of GLD shares, don’t expect to be redeeming them in physical gold anytime soon. But first, let’s go over some background information on how an ETF is structured. Many investors prefer ETFs as a way to spread out market risk across multiple companies and indices. For example, an investor would be better off buying an ETF like SPY, which tracks the S&P 500, than buying every S&P 500 stock individually. In short, ETFs lower transaction costs by issuing shares in lots known as “baskets” for a corresponding quantity of the designated assets. Most ETFs are organized as trusts. The company that starts the process – usually called the “sponsor” – bears all the legal and other costs of forming the trust. These include dealing with the SEC, selecting the “Trustee” and the “Custodian,” issuing the first fund shares, and depositing an initial tranche of the designated assets (in the case of GLD, physical gold) with the custodian. GLD’s sponsor is World Gold Trust Services (WGTS), which is owned by the World Gold Council (WGC), an industry marketing organization funded by gold-mining companies. BNY Mellon Asset Servicing is GLD’s trustee, and HSBC Bank USA is the custodian. As the custodian, HSBC keeps track of and stores all of the gold that backs GLD’s shares. Currently, HSBC’s vaults contain more than 41.3 million ounces of gold, secured safely beneath the streets of London. According to the company, gold held by the trust is not traded, leased, or loaned under any circumstances, and no additional shares can be produced by cash or derivative contracts. Each share represents about one-tenth of an ounce of bullion at current market prices. But the question most important to many gold bugs is “How can I redeem my shares in physical gold?” For most investors using GLD, this is a difficult – and nearly impossible – process. Fact #1: In order to qualify to redeem your GLD shares in physical gold, you need special permission from SPDR, which is typically reserved for brokers and market-makers like Goldman Sachs and JPMorgan Chase. Fact #2: Shares can only be redeemed in batches of 100,000, which is equivalent to 10,000 gold ounces (a little over $16 million at today’s market price). Fact #3: To add insult to injury, deep inside GLD’s 10-K we found that the fund retains the option to redeem gold requests in cash rather than the physical metal. Translation: Even with $16 million in GLD, you still might not be able to receive your physical gold upon request. And there’s more: since GLD is structured as a grantor trust, investors don’t pay taxes similar to regular ETFs. Fact #4: As a GLD investor, you pay taxes on the underlying asset – in this case, gold. Gold, however, is taxed as a long-term holding at a rate of 28% instead of the 15% capital gains tax you would pay on other equities. That can certainly eat into your returns. At least, according to GLD spokesman George Milling-Stanley of World Gold Trust Services, the fund is truthful about its gold holdings. Many wonder how GLD is able to procure so much gold in the first place. But, Millings-Stanley states, the process is easier than you would think: nearly all the gold comes from another part of the HSBC vault. HSBC’s vault – which he claims is “about the size of a football field” – holds both the gold of many of HSBC’s clients and GLD: “HSBC stores both allocated and unallocated gold. When the trust (GLD) issues new shares, the metal to back them comes from clients of HSBC, who have unallocated pool gold stored with the bank and are willing to sell at the price offered. Once the authorized participant completes the transaction, the gold is moved from the unallocated section of the vault to the area assigned specifically to us (GLD). Occasionally, gold will have to come from outside of HSBC, but there’s always been sufficient bullion available from other London vaults. So transport isn’t a problem, and the market maintains a very careful chain of custody.” For those skeptical that GLD actually has the gold it claims to have in its vaults, he says to check the serial numbers, refiner name, fineness, and weight of every bar, which is updated and posted every Friday on the company’s website. He also points to independent audits conducted by Deloitte & Touche, but confesses that the firm does not count each individual bar. Rather, they certify the “adequacy of accounting procedures.” For those of us who enjoy the safety and protection offered by physical gold, GLD can have its gold holdings audited until the cows come home. It still doesn’t change the fact that only a select few of GLD’s institutional investors can redeem their shares in physical gold when the time comes. If you are simply looking to ride the price of gold, go ahead and use GLD as a proxy – just don’t confuse ownership of shares with ownership of metal. Remember that physical gold is the only real weapon against governments devaluing their currencies and the runaway inflation that comes with it. Gold has been used as money for thousands of years and has historically always maintained its purchasing power, even in times of hyperinflation when paper currencies became worthless. Case in point: In the 1930s, when gold was trading at $35 per ounce, you could have bought a good-quality suit for a one-ounce coin. Today, at a price of around $1,600/oz, you can still get a good-quality suit for one ounce of gold. Try to do the same with 35 of your 1930s paper dollars. Fortunately, those looking for more than what GLD has to offer – namely, protection from inflation and real exposure to gold – have a few options. A new company, the Hard Assets Alliance, offers an easy way to buy and sell physical gold – and store it at a very reasonable rate in any one of five secure vaults in the US and abroad. Investors can take delivery of their gold anywhere in the world. To learn more, click here to download the SmartMetals Action Kit, a free report from the Hard Assets Alliance.