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. Last Updated: 07/27/2016

Gref Warns of Market Bubble

Economic Development and Trade Minister German Gref on Thursday warned that the country's stock markets risk overheating as unprecedented levels of cash pour into Russian stocks.

Speaking at a Cabinet meeting, Gref said the government was "very afraid of a so-called bubble forming." Gref is the third top government official in two weeks to voice concern about the rate of market growth.

With both of the main exchanges currently enjoying record trading levels and volumes, Gref's comments signal that the government is paying ever-closer attention to the markets and is concerned about the economic consequences of a possible collapse.

"The government may be afraid that a fall in the markets will destabilize the economy," said Roland Nash, chief strategist at Renaissance Capital.

According to Renaissance Capital, the country's stock markets gained $150 billion in value in the first two months of this year -- the same amount as during the three years preceding the arrest of Yukos CEO Mikhail Khodorkovsky in fall 2003.

The RTS Index has doubled over the past year, hitting a record 1,516 points Sunday. A day later, the ruble-denominated MICEX shut down temporarily after a record $3.1 billion in stocks changed hands.

The MICEX, the country's largest stock exchange, posted a note on its web site advising traders to update their trading hardware and software.

In such an environment, state officials are acting responsibly, analysts said.

"It's important for the regulators to remind that markets go down as well as up," said James Fenkner, head of Red Star Asset Management, which manages $100 million in Russia and the CIS.

"It's very difficult to justify the current performance of stocks. What we could be at now is the start of the bubble," Nash said. RenCap sees "no good fundamental explanation for the market's performance," he added.

Recent rises in the markets are being driven largely by interest from Western investors, analysts say.

In February, the flow of Western funds into Russia set an all-time record of close to $1.5 billion, according to data by Emerging Portfolio Fund Research, a U.S.-based researcher that tracks funds with a value of $5 trillion.

"Money has to go somewhere, and the appetite for risk is very high. Other emerging markets are doing well, too," said Peter Westin, chief economist at MDM Bank.

But as well as those who are willing to take a chance on the Russian markets, there are those who say the rise in stock prices is justified, with Russian companies still trading at a discount to peers.

"If you're waiting for a big fall -- forget it," said Sergei Orlov, a trader with UralSib brokerage. "There are still very, very, very many shares that are undervalued on the Russian market. That's right, three verys."

In addition to foreign interest, stocks prices are being helped by more Russian interest. Most fund managers now expect money held in Russian savings accounts to come to the stock market.

"Soon, we'll see Russian money coming on the market and giving the rally strong support," Orlov said.

Domestic inflow will work alongside a global investor appetite for risk, as well as an abundance of available cash due to low interest rates. Booming prices for commodities will also continue to attract investors to Russia, analysts said.

Yevgeny Gavrilenkov, chief economist at Troika Dialog, said the current situation had elements of a bubble, but that so far there appeared to be no indication of an imminent market crash. "Sooner or later, there would be a correction," he said. "But it doesn't mean that it would be a fall, the market could just freeze for a while."

"It all comes down to earnings. And in Russia, the problem is that the great economic growth does not necessarily translate into earnings growth -- unless oil prices continue to rise," said Andrew Howell, head of Citigroup's emerging market strategy team in New York.

More confident analysts, such as William Browder from Hermitage Capital, say they expect the RTS Index to be higher in 18 months than even the current peak levels. Hermitage Capital has $4 billion under management.

A report released last week by the world's largest banking group, Citigroup, suggests that the optimists may have justification.

Citibank calculated that at present, only 1.3 percent of all U.S. holdings are in emerging markets, which include Russia. Should that percentage rise to a likely 4 percent, the bank argues that flows of fund money into emerging markets will maintain current levels for the next four years. "If that happens, the size of Russia's equity market will double from where it is now," Fenkner said.

Staff Writer Valeria Korchagina contributed to this report.