Without a visa: for decades to come, Albania will look as if invaded by an armada of Martians in miniature flying saucers

National Review, April 21, 1997 by Radek Sikorski

PEOPLE who share my outlook on the Russian debt and equity markets were cheered by the feel-good press that burbled from Helsinki and assorted world capitals after the summit meeting last month. Not that we believed the summit spin -- but you can't be a seller unless there are some buyers around, and they need to be encouraged until they are relieved of their excess cash.

Some interesting numbers are coming out of the Russian markets these days. For example, it is believed that over 60 per cent of the internal debt of Russia is now held by foreigners. This is principally in the form of "gekkos" (sic) or Russian Treasury bills, formally known as GKOs. The Russians themselves don't seem to want to buy them, preferring to hold onto their cache of $30 or $40 billion of U.S. currency. What, one wonders, do they know that the foreigners don't? After all, you can earn fat double-digit returns in GKOs even after hedging out the currency risk. Could it be that the government is printing them like cents-off coupons to meet back-wage demands? Is that why interest rates in Russia are rising to what the brokers tell people are "attractive" levels?

Perhaps more illustrative than mere statistics and broker chatter is a little story that I heard out of Moscow a couple of weeks ago. A bit of background first: when unhappy gangster business partners want to "send a message" to a bank's management to change its behavior, they set off a bomb outside the premises. Subtle, but often effective. Well, a friend of mine was struck by the extraordinary security he had to go through before entering the National Reserve Bank, which is closely allied with the giant Gazprom, the source of much of Prime Minister Chernomyrdin's wealth. The embarrassed executive who accompanied him admitted that three bombs had recently been set off in front of the bank. The problem, though, was that the bank was involved in so many shady deals that the management couldn't figure out who was warning it to back off from what. The management has literally been made an offer it can't understand.

In case the reader wonders why I am so fascinated with the finance and economics of a near basket case such as Russia, the answer is that a) it has the resources and people to make a fast comeback under the right leadership, which does not mean the criminals now in charge of the government, and b) we may need the Russians again as allies in the future, which means they should not be treated with the cravenness and dishonesty that characterizes the Clintonistas chosen to deal with them.

Now that the Bre-X Indonesian gold-mining scandal has left a smoking ruin of the markets for the so-called junior gold-mining shares, it's time for the survivors to pick their way through the rubble. Carefully. After all, as the Carthaginians could have told you, sometimes there are no comebacks. But there may well be value in some of the small gold companies sooner rather than later.

The panic selling at the end of March was made worse by the usual frantic margin calls and delayed quotations. Since many people were unable to raise enough cash by selling their Bre-X shares, they sold other gold mines as well, and the process fed on itself.

One of the earliest sellers of Bre-X was investor and investment advisor Bob Bishop, who works out of Lafayette, Calif., near San Francisco. Bishop was selling Bre-X when it got over $20 a share, which is a touch higher than the $2 it was selling at by the end of last month. He admits he didn't realize the extent of the funny business going on in Indonesia, but he sensed enough to get himself and his clients out.

He thinks this might be the time to buy. "I think the [gold stock] system has been pretty well flushed out, and if you can't buy stocks after a selling panic, then when can you buy them? The business of the major mining companies taking over the smaller companies is going to continue, because the majors need to expand their reserves and they aren't finding the gold on their own." The risk to the gold shares, as he sees it, is if the broader equity averages keep declining.

Even Bishop admits, though, that "The Bre-X business has lasting implications for how business will have to be done going forward. Due diligence will be much stricter. There's a limit on what you can do as a fund manager -- there are certain articles of faith that have to be accepted."

And any comeback is unlikely to include Bre-X stock, even if it turns out that there is some economically mineable gold on its Indonesian site. The Indonesian government is likely to pull the concession, and it won't get an argument from the mining world for having done so. After all, the country has a reputation for honesty and straight dealing to uphold.

As you may have noticed, I prefer to think of arbitrages and spread trades rather than outright long positions. Right now, I think you'd do well to buy British 10-year gilts (government bonds) and sell short the equivalent value in 10-year French bonds. Not only do you get a positive carry (the Brits pay more than the French), but the British economy is in better shape. In fact, even though the Labour government will likely not go into the European Monetary Union at the start date, its balance sheet and budget deficit are likely to look better than those of its French counterpart by early next year. Social democrats such as Tony Blair may not always be growth-friendly, but they've decided to join the bond market rather than fight it.