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. Last Updated: 07/27/2016

Oil Propels RTS to a Record High

The benchmark Russian Trading System index rose by one-half of a percentage point on Monday to set a new closing record, capping an unprecedented summer rally that has channeled foreign investors' surplus cash into Russian equities.

Traders said they hoped the record would erase the misfortunes of the past year. Since the last all-time high, set on April 12, 2004, back tax claims against several companies, a lack of major reforms and the media circus surrounding the trial of former Yukos CEO Mikhail Khodorkovsky have sent shares on a rollercoaster ride that they only began to recover from after the Khodorkovsky verdict.

"We're having last year's rally this year," said Eric Kraus, chief strategist at Sovlink Securities. "Last year's rally was aborted by the Yukos story ... and it restarted days after Khodorkovsky was sentenced."

Russian shares listed on the RTS, the rival MICEX exchange and those traded abroad have been stagnant for most of the year. After a surge in February, the RTS shed half of February's gains in March and hardly changed in April and May.

But since the May 31 sentences of Khodorkovsky and his business partner Platon Lebedev to terms of nine years in prison, the market has gained over 100 points, or more than one-sixth of its value. The record high came in spite of the approaching vacation season, when most traders and investors prefer to take things easy.

"We've broken ground right in the middle of summer, and that's left a couple of people flat-footed because they weren't expecting this kind of movement in the summertime," said Nick Mokhoff, head of sales trading at Brunswick UBS.

The index had been hovering at just under the record for more than a week. In the end, it appeared to take the death of King Fahd, the ruler of the world's top oil producer, Saudi Arabia, to push the index over the top.

After King Fahd passed away on Monday morning, oil prices rose to $61 per barrel, pulling in their wake Russian stocks like LUKoil. The RTS closed at 782.40, up 3 1/2 points on the back of gains in LUKoil, Norilsk and Sberbank shares.

"The passing of King Fahd is obviously going to put some jitters into the market overall," said Kim Iskyan, head of research at MDM Bank. "And when oil prices go up, Russian shares head that way too."

Foreign cash fueled much of the rally, traders said, although precise figures were not available because many Russian shares trade abroad. Portfolio investors abroad have oversubscribed to several initial public offerings, or IPOs, of Russian companies, which has raised interest in the Russian market in general.

"With IPOs, people don't say, 'I've got to sell a Russian stock to buy the new offering," said Thomas Adshead, head of research at Metropol investment house. "Good companies increase Russia weightings. ... Russia has underperformed Eastern Europe over the last year, and those funds that allocate money to emerging Europe have been taking profits from Eastern Europe and shifting them to Russia."

But some analysts and traders questioned how long the rally would last.

All Russian companies, with the possible exception of those in the retail sector, are threatened by factors over which they have no control: political stability, major reforms, macroeconomic management and, not least, the price of oil.

Over 40 percent of companies in the RTS index receive the bulk of their revenues from oil or gas production and distribution, according to MDM Bank's estimates. Oil, gas and metals prices have all surged over the past year, although the price of steel has since shed some of its gains.

"If commodity prices had been flat over the last 12 months, the Russian market would have done badly," Adshead said.

Oil companies' profits do not match oil price gains, because the government taxes away a large chunk of earnings. But were prices to dip, some investors would dump Russian oil shares because they had bought them to ride the coattails of rising oil, Adshead said.

The Russian market still suffers from a perception of political risk and a big question mark over the rule of law, although that has ebbed since last year, analysts said.

"This is a correction from bearish sentiment, not a move to bullish," said Al Breach, a strategist at Brunswick UBS. "The degree to which people are really excited about this country is not that big -- this is not like a boom market." In market parlance, "bearish" implies that investors are pessimistic and set on selling stocks and "bullish" that they are willing to buy them.

Breach said that strong macroeconomic conditions in Russia and abroad were bound to outweigh political concerns. Russia has been running budget and trade surpluses and though GDP growth has slowed, it is still estimated to reach almost 6 percent this year.

Moreover, with the global developed markets posting far skimpier returns, Russia has become a land of opportunity for investors willing to tolerate risk.

A successful liberalization of shares in Gazprom, set for the end of the year, would increase Russia's weighting in the benchmark Morgan Stanley Capital International, or MSCI, Emerging Markets index, Mokhoff said. Many institutional investors invest in shares proportional to their weight in the index.

Emerging market investors "will find themselves drastically underweight when MSCI reweighs Russia," Mokhoff said. "This just points to potentially more buying ahead of us."

The RTS dollar-denominated exchange has far smaller trading volumes than the ruble-denominated MICEX and many Russian companies trade only on foreign exchanges. But the RTS is still watched as it provides continuity and an indication of trends over the past decade.

The RTS today is not the same as the one that broke the record almost 16 months ago. Yukos' share of the index is not less than 1 percent, while Sberbank, the state-owned semi-monopoly in private banking deposits, now accounts for one-seventh of the index, from just 8.5 percent before last year's high.

A more widely watched benchmark of Russia's performance against its counterparts in the developing world is MSCI's Russia index, which rose by 21.6 percent in the year to Friday, against 11.2 percent for the broad MSCI Emerging Markets index.