The Siberian Century

At a recent investment conference, the Russian government set out its goal to spend $1 trillion on infrastructure in the next 12 years. Capital & Crisis’ Chris Mayer explores what kind of investment opportunity that spells for you.

At the foot of the snowcapped Caucasus mountain range in southwestern Russia is the little resort town of Sochi. Stretching along the coast of the Black Sea, it is a sort of Russian Riviera. The pretty and warm waterfront town, framed against majestic mountains, was a favorite spot for vacationing Soviet officials.

This was where Russian officials chose to unveil their big plans. At a recent investment conference, the Russian government set out its goal to spend $1 trillion on infrastructure in the next 12 years.

(Russia will have to put on quite a pony show, because the plan relies mainly – to the tune of 80% – on private money. Only 20% comes from the Russian treasury. The Russian government, though, is not poor. It has about $127 billion in oil revenues stashed away in its reserve fund.)

In any event, Russia’s plan makes it the biggest infrastructure spending plan outside of China, which spent nearly $1 trillion on infrastructure projects during 2004-2006 alone.

China, like a molting pigeon, keeps shedding its old feathers and changing in dramatic ways. Russia, too, wants a new look. It needs it badly. In some cases, Russia is decidedly worse off than even a decade ago. For example, in the 1990s, Russia had over 1,300 airports. Today, there are about 250 – most of which need serious repairs.

Russia’s road system is woefully poor. Even big cities often depend on single-lane roads. Russia’s road system is only one-tenth as long as America’s. Only 5% or so is good quality. In Russia, that means having more than one lane and a surface that doesn’t buckle under the weight of a car.

What about the railroads? As befits the largest country in the world, Russia’s railroad system is one of the longest in the world. Yet it is still half the length of the U.S. and filled with gaps. Much of it is aging, rusting in the pale sun of the Russian plains and crumbling in the arctic winds from the north. Freight cars crawl along at average speeds of no more than 25 miles per hour.

Still, the Russian economy has sped along like "a fiery and matchless troika" – in the words of the great Russian writer Gogol. It’s something of a miracle, given the shabby shape of its skeletal structure. (Gogol also wrote how the "the road is like a cloud of smoke… the bridges thunder." Maybe Russia’s infrastructure was never any good.)

According to the Financial Times, "Economic growth averaged 6.7% for 1999-2006… [and] 7.7% this year." Companies can’t afford to ignore the place, despite widespread corruption and a stifling bureaucracy. Investors, too, will have to keep an eye on Russia. That massive spending plan is, in the words of the FT, "a potential bonanza for international construction and engineering groups."

ABB Ltd. (NYSEL:ABB) shareholders can toast Moscow and down a shot of vodka in thanks. ABB, you may remember, is our Swiss-Swedish engineering firm and the world’s largest builder of power grids.

And guess where a good chunk of that $1 trillion will go? Some $480 billion will go toward adding capacity and repairing Russia’s electrical infrastructure. The Russians named the plan "GOELRO-2" after Lenin’s 1920s plan to electrify Russia. Incredibly, after building only 30 nuclear reactors during the entire Soviet era, Russian President Vladimir Putin plans 26 over the next 12 years.

As part of this effort, Russia’s electricity monopoly will sell off 20 power generation companies. Some call it the biggest and most complicated industrial overhaul since the Soviet collapse. The sale will bring in as much as $120 billion. The proceeds will go toward shoring up capacity and helping cope with surging demand.

Of the remaining money in the pot, there’s some $400 billion slated for rail. This is why FreightCar America (NASDAQ:RAIL) executives drool when they talk about doing some joint venture in Russia. Then there is another $30 billion for airports…

One of the most interesting things about this plan is where the money goes regionally. More than two-thirds will flow west of the Urals, to Russia’s Asian wing. That is, to Siberia.

Talk about image problems! Until the 19th century, Siberia was just a haven for trappers, traders, numerous scattered native tribes, as well as outcasts and prisoners. In the 20th century, it became the locus of the infamous gulag, a nasty system of forced labor camps that reached its apex under Stalin.

But in this century, Siberia will play a central role in the economic resurgence of Russia. (It also has nine of the 10 coldest cities in the world, considering populations of only half a million or more.)

"Russia’s power will grow with Siberia," once wrote the Russian poet Mikhail Lomonosov. Indeed, why not? It is here where all of Russia’s natural treasures lay – 85% of its natural gas, 80% of its oil and coal, plus gold, platinum, nickel, diamonds, silver and other metals, and timber. "We’ve got rich reserves of just about the whole periodic table," cracked a Siberian governor.

The opportunities are so large that Muscovites wonder, "Could this be the Siberian century?"

I know what you’re thinking. As an investor, you’re about as interested in Russia as you are in acquiring a pet alligator. It eats, it bites, and it gives no quarter. Yes, Russia has a definite image problem. It labors under a lot of stereotypes.

It is cold and gray. The people are grumpy and drunk. The government is corrupt and mean. Violence is all too common. But stereotypes often melt away when you are on the ground in a place. Anthony Bourdain, the travel writer, remarks in his new book No Reservations: "In Russia, people are not outgoing, or cheerful or even particularly friendly… until you get halfway down the vodka bottle, that is."

Bourdain downed plenty of vodka during his stay in Russia. And he found that if you do, the Russians open up. Under a vodka-induced haze, Russia started to make sense. "Soon you begin to understand the magic of the birch forests, the fierce Russian winters, the sad majesty of black crows on snow-covered fields. You vow to reread Tolstoy, to read Gogol – in Russian. Then you throw up in your shoes."

It’s sort of like that, too, when you try to wrap your head around investing in Russia. Not in the sense that you have to drink a lot of vodka to understand Russia. But there’s a lot that’s hard to understand. Yet there’s also a lot of appeal. Like China or India, it’s a tough place to invest in. But like China and India, it’s where the growth is. It’s where magical changes take place virtually overnight.

Consider that Russian home prices have gone up for five consecutive years. A mortgage industry that began only in 2002 issued $20 billion in mortgages in 2007. There are over 36 million cars in Russia. As recently as 1995, there were only 11 million. Plus, the Russians are traveling more. Some 7.7 million traveled abroad last year, compared with only 2.6 million in 1995.

Finally, consider that there are over 66 billionaires in Moscow alone, second only to New York. Russia has over 119,000 millionaires.

So Russia has real hope and progress now, not the kind that sits like dust at the bottom of an old coffee mug, but the kind that fills a vodka glass and buys caviar. It’s the kind where you, as an investor, can make a little money.

Regards,

Chris Mayer
for The Daily Reckoning
December 27, 2007

P.S. I’m not ready to jump into Russia in a big way yet. But I’ve got one stock that benefits from trends in Russia; plus gives you a free turn at a potentially valuable Russian mine, one of the largest zinc projects in the world…you can find out more in this month’s issue of Capital & Crisis.

Today’s big headline news is that Pakistan opposition leader Benazir Bhutto was assassinated in a suicide attack on a campaign rally. As Bhutto was leaving the rally, reports say, she was shot in the neck and the chest. The gunman then blew himself up, killing 20 others.

Of course, geopolitical instability such as this is sure to have an effect on the markets…stocks are down, and gold, oil and bond prices rose on the news this morning.

Crude oil reached above $96 a barrel this morning, on the news of the assassination in Pakistan and on the Energy Department’s weekly inventory report, which said, "oil inventories fell by 3.3 million barrels last week, more than double the 1.3 million barrel decline analysts surveyed by Dow Jones Newswires had expected on average."

Dragging down stocks was the weak increase in durable goods…economists were hoping for a 2.2% increase and only got 0.1%.

*** And here’s the shocker of the day: consumer confidence is up in December, says the Conference Board report.

MarketWatch reports: "The consumer outlook on business conditions, employment, inflation and stock prices ‘improved marginally,’ according to Lynn Franco, director of consumer research at the private Conference Board."

But – wait…there’s more. The report also says that consumers remain "far from optimistic." That sounds about right.

According to our currency counselor, Chuck Butler, there are some people who are optimistic…about the U.S. dollar, of all things.

"I read an article today that really got me fired up," Chuck tells us. "The big brokerages like the ones we’ve been talking about that are taking infusions of cash from Sovereign Wealth Funds, are now saying that this will continue, and thus we should see an end to the dollar weakness in 2008.

"I would bet a dollar to a Krispy Kreme that these guys calling for a dollar rebound are long dollars!

"Oh geez…because these knuckleheads all had to beg for help…oh, never mind, I just don’t want to get into this stuff. But if they are all saying it…it’s like a self-fulfilling prophecy. These guys are calling for a 3.3% rise in the dollar next year. Of course they don’t say when that happens…and I, for one, wouldn’t be surprised to see a 3.3% rise after the euro hits 1.50!"

So… Chuck isn’t buying the whole ‘end of the dollar weakness in ’08’ talk…and neither are we. This isn’t a surprise to long-time DR sufferers, but we’re still sticking with gold.

We turn to Outstanding Investment’s Byron King to back us up here…

"Throughout the 1990s and into the early 2000s, gold was relatively low priced. At some points, gold was selling for under $300 per ounce. (Ah, the good old days.) Now, of course, gold is north of $800 per ounce. But back in the lower-cost days of a decade ago, there was little investment in new mines and production facilities. There was, in short, an investment holiday in new production facilities.

"Today there is a gold mining boom going on, but that boom is encountering rising costs for – you guessed it – concrete, steel, machinery and labor. A lot of projects that are on the books of many companies may never get built because of rising capital costs going forward.

"So the question for us is whether there are any gold miners out there that are going to be increasing output, but not paying the premium prices for current development? Yes, there are."

That’s it for us today. Bill is still on the loose in Argentina, enjoying a holiday break, and your managing editor is still stuck in bed, blowing her nose every five minutes (which, of course is not very conducive to typing a lot).

Until tomorrow,

Short Fuse
The Daily Reckoning