Oil continues to hover near multi year highs with yesterday’s surprise inventory draw numbers only adding to the bullish posture of the market. Although the Biden administration has made several attempts to jawbone the price of oil lower, first by appealing to OPEC to increase production and them hinting that it may release some stockpiles from the SPR reserve most analysts believe that crude and the whole hydrocarbon complex will at very minimum remain steadily bid for the foreseeable future.
- Global demand for oil favors oil rich RSX ETF
- Russian equities are in a tug of war between inflation and commodity spike
- Yield harvesting RSX offers a low risk way to play the trend
Global demand for oil is almost at pre-pandemic levels of 100mbp per day and the re-opening of major business travel routes should boost demand further. In Europe, with natural gas prices already at very high levels, any deep freeze conditions this winter could exacerbate the already elevated price levels.
All of this bodes well for Russia which stands as one of the pre-eminent hydrocarbon exporters in the world and whose oil and gas complex has already locked in massive gains on the production due to the 80% rally in crude. The easiest and most natural way to play this theme is through the RSX ETF which provides a broad exposure to the Russian oil and gas industry and trades more than 3M shares each day. The stock has responded well to the rising price of oil gaining 15% since the summer. Although this is a respectable move it is rather muted in nature given the outsized gains in the underlying commodities.
The reason for the modest gains in Russian equities have more to do with underlying turbulence in the Russian economy which has tempered the buoyant recovery in hydrocarbon demand. Russia continues to suffer from the scourge of COVID registering an average of 1000 deaths per day this month. More importantly the country is facing serious inflation pressures as it continues to import a vast array of goods that are now subject to supply chain constraints from many Asian producers. The Russian central bank has already raised the benchmark rate to 7.5% – one of the highest amongst the EM – and has threatened to hike another 100bps in December if inflationary pressures do not abate. All of that has created tight credit conditions for the Russian economy and has compressed P/E spreads for equities.
So the push and pull between higher commodity prices and elevated inflation has clearly curbed some of the upward momentum in the RSX nevertheless the ETF may be an excellent instrument for a low risk yield stripping play. At current levels the RSX provides a very respectable 2.75% yield and given the fact that most of the Russian oil majors are seeing 14-18% Free Cash Flow yields at current commodity spot prices chances are good that many of the Russian companies in the ETF will raise their dividend payouts over the course of the next year. Meanwhile the RSX offers listed options on the instrument and investors could sell near or at the money calls on a bi monthly basis to enhance their return.
As long as the price of oil remains within the $70-$90 range for 2022 the value of RSX is likely to remain stationary at worst and appreciate at best. Investors therefore could harvest dividend yield and option premium in a relatively low risk trade with possibility of double digit annual returns.