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Commodity Prices May Trigger Former Soviet Rally: Russia Credit

Russian and Kazakh debt is catching up with the rest of emerging markets as commodities prices rise after the U.S. decision to add money to the economy.

Russia’s government bond due in 2015 climbed after the Federal Reserve pledged Nov. 3 to buy $600 billion in Treasury securities through next June, pushing the yield to 2.848 percent today, close to a record low. The yield on 11.75 percent notes due in 2015 of KazMunaiGaz National Co., the Kazakh state oil and gas producer, fell 10 basis points, or 0.1 percentage point, to 5.186 percent. Benchmark bond yields in Brazil and South Africa, two other emerging-market commodities exporters, reached two-week and 10-day highs in the same period.

Russian dollar bonds have returned 12.8 percent this year, compared with a 16.6 percent advance for notes from the largest developing nations, JPMorgan Chase & Co. indexes show, as sluggish growth and declining interest rates deterred investors. Brazilian foreign-currency notes advanced 14.5 percent and Philippines debt climbed 18.2 percent in the same period. Rising prices for oil, gas and metals boost revenue for Russia and other members of the Commonwealth of Independent States whose recovery is tied to global commodity prices.

“There is a decent chance you can get outperformance because we are in a pretty decent environment for commodities,” said Ian McCall, a director at Argo Capital Management in London who manages $500 million of emerging-market debt. The former Soviet Union “benefits the most of the group, as countries like Russia and Kazakhstan are commodities exporters,” McCall said.

Commodities Rally

Prices for commodities increased to the highest level since 2008 after the Fed announced it will buy more Treasury bills to inject money into the economy, a process in the U.S. and U.K. known as quantitative easing.

Commodities have surged to a two-year high, as cotton and gold reached records, silver touched the highest level in 30 years, and corn futures advanced to the highest price since August 2008. The Standard & Poor’s GSCI Index of 24 commodities gained as much as 1.8 percent yesterday to the highest since Oct. 2, 2008.

“The announcement by the Fed is definitely supportive for emerging-market credits,” said Sergey Dergachev, who helps manage $6 billion of emerging-market debt at Union Investments in Frankfurt. The Fed’s buying of bonds in the U.S. “will prolong the relatively attractive risk appetite and Russian issuers should benefit from this ‘hunt for yield,’” he said.

‘Implicit Hedge’

Russia is the world’s biggest energy exporter, while Kazakhstan, holder of more than 3 percent of the world’s oil according to BP Plc, is the largest uranium producer. Russia pumped 10 million barrels of crude a day last year, versus 2.3 million for Kazakhstan. The relative cheapness of Russian and Kazakh debt is an added lure for investors as oil prices rise.

“Russian assets offer an implicit hedge against the potential inflationary consequences of quantitative easing by the Fed,” Scott Licamele, a partner at foreign-exchange broker LoginFX in Moscow, said by telephone. “As a major commodities exporter, the economy will continue to perform with a weaker dollar and correspondingly higher oil and metals prices.”

The ruble was little changed at 30.6350 per dollar in Moscow today, and has weakened 1.1 percent versus the greenback so far this year. Non-deliverable forwards, or NDFs, which provide a guide to expectations of currency movements and interest rate differentials and allow companies to hedge, show the ruble at 30.9918 per dollar in three months.

Default Swaps

The cost of protecting Russian debt against non-payment for five years using credit-default swaps rose 3 basis points to 138 today, down from this year’s peak of 217 points, according to data provider CMA. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a debtor fail to adhere to its agreements.

Credit-default swaps for Russia, rated Baa1 by Moody’s Investors Service, its third-lowest investment grade, cost nine basis points more than contracts for Turkey, which is rated four levels lower at Ba2. Russia swaps cost as much as 40 points less on April 20. Brazil stood at 97 points.

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries rose 11 basis points to 200 points, according to JPMorgan EMBI+ indexes. The difference compares with 138 for debt of similarly rated Mexico and 176 for Brazil, which is rated two steps lower at Baa3 by Moody’s.

Eurobonds Undervalued

“We recommend paying attention to Eurobonds of CIS countries, particularly Russian Eurobonds as those are currently undervalued compared with other emerging markets, such as Brazil and Mexico,” Dmitri Gritskevich, fixed income analyst at Promsvyazbank in Moscow, said in a telephone interview.

The yield spread on Russian bonds is 44 basis points below the average for emerging markets, near to the smallest difference since September 2009 and down from a 15-month high of 105 in February, according to JPMorgan Indexes. Russian notes yield 14 basis points more than Brazilian bonds and 53 points more than Mexico’s.

Russia expects gross domestic product will grow 4 percent this year compared with 7.5 percent for Brazil and 10.5 percent for China, according to official forecasts.

Kazakhstan’s GDP expanded 7.5 percent in the first nine months of the year, Prime Minister Karim Massimov said Oct. 25.

“I assume Russia and CIS credits to perform very well and better than Asian and Latin American names, but should risk-aversion materialize, Russia and the CIS should be hit much harder,” said Dergachev at Union Investments.

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