Why Most Americans are Missing This Ridiculously Undervalued Sector

As an American living in Colombia, I have seen firsthand how watching the U.S.-based news feed can skew investor perspectives and limit opportunities. Sometimes looking beyond the popular press to the real facts behind the story can lead to some great investments.

For example: Ask about investing in Colombia and most investors would wonder if you’ve gone mad with visions of drug lords and rebel groups coming to mind. Why? Because these dramatic problems are all that plays on the 24-hour news feed.

I know I have earned consistent double-digit returns on my investments in Colombia. But to overcome my limited and media-driven understanding of the opportunities, I had to dig deeper and look at the facts.

And that is exactly the case with another investment opportunity I have been watching. If you are following the U.S.-based news feed, all you see about this country recently is its interference in a neighbor’s conflict and the power-hungry ambitions of its president. 

Look beyond the superficial sound bites and you see record low stock valuations and annualized investment returns of 45% and higher.

#-ad_banner-#How Do You Say ‘Record Low’ in Russian?

Prices for stocks on the Moscow Interbank Currency Exchange (MICEX) have fallen to just 4.7 times trailing earnings, a quarter of the 19.1 multiple the S&P 500 commands. Prices have fallen so far that the index is trading at its steepest discount to emerging market equities since at least 2005.

Following the index lower, the Market Vectors Russia ETF (NYSE: RSX) trades for just 6 times the trailing earnings of companies held in the fund and is down 25% over the past year. The fund holds shares of 48 companies, many of which U.S. investors do not have access to with ADRs. Reflective of the overall economy, energy makes up 43% of the fund, followed by materials (16%), financials (12%), telecommunications (10%) and consumer staples (9%).

Of course, two factors are at play here. The conflict in Ukraine has led to international condemnation and sanctions on Russia. The conflict pushed both Ukraine and Russia to the brink of recession, and the ruble lost 28% of its value against the U.S. dollar since the beginning of the year. In fact, the ruble is now at a record low against the dollar. 

The second problem for Russia has been the drop in oil prices. Oil and natural gas account for more than two-thirds of the country’s export revenue, so any rebound in prices could send estimates for economic growth higher. 

How Risky is Russia, Really?

I won’t attempt to guess at a resolution to the crisis in Ukraine. The country called elections held Nov. 2 in the eastern region illegitimate, and a second cease-fire agreement between the government and separatists is still being hotly negotiated. 

Beyond the images of a broken cease-fire and the politicking by leaders, there is good evidence that Russian stocks can withstand this economic speed bump and may provide strong returns in 2015.

Just over $15.5 billion in external corporate and bank debt is due in February. While there will be market chatter about the potential for default between now and then, there is really no reason why a default would occur.

Against all the pessimism, the country’s finances are in relatively good shape. Russia has tripled its gold reserves since 2005, adding 150 metric tons this year, and now holds 1,185 tons of the precious metal, according to Bloomberg calculations. The country also has $439 billion in foreign currency reserves and another $85 billion in the National Welfare Fund. 

Russia signed two major gas deals with China earlier this month that could account for as much as 17% of China’s gas consumption by 2020. 

While Russian economic growth slowed in the third quarter, it still managed to post a 0.7% gain, better than the 0.2% growth registered in the European Union over the same period. And we got news Friday that Russia’s economy grew at a 0.8% pace in the first 10 months of the year, well ahead of the 0.3% full-year forecast of its central bank.

Any stabilization in oil prices or momentum on a peace deal in Ukraine could see Russian stocks rocket higher. RSX jumped 16% in the two months following Vladimir Putin’s May 7 endorsement of the Ukraine presidential election and call for delaying rebel independence referendums.

Hedging Downside While Waiting for a Rebound

Rather than simply buying shares of RSX, I want to use a covered call strategy to bring in immediate income that will offer us some downside protection as we wait for a rebound.

With RSX trading at $21.42 at the time of this writing, we can buy 100 shares and simultaneously sell a RSX Jan 22 Call, which is trading around $0.40 per share ($40 per contract). This gives us a net cost of $21.02 per share, offering us 2% downside protection.

If RSX rises above the $22 strike price at expiration on Jan. 17, our shares will be sold for that price. In this case, we will make $0.98 per share for a profit of 4.7% in just 54 days. If we were able to make a similar trade every 54 days, we could earn a 32% rate of return in a year.

If RSX fails to rally above $22 by expiration, we keep the shares and the option premium. We then have the opportunity to sell another call against the shares to generate more income and lower our cost basis further. The corporate and bank external debt due in February should keep volatility high and options premiums attractive.

Beyond the attractive value and potential for upside, RSX has a 3.35% yield for investors willing to wait out the near-term problems. While the economy could remain weak for the next couple of quarters, there is really no rational reason for prices to be this low. 

A covered call is the perfect way to earn money from an undervalued stock or ETF. While stockholders simply hold for a rebound, covered call traders actively earn income while they wait. It’s sort of like “renting” your shares out for cash. And it may be the easiest way to generate income in this market. 

If you’re interested in learning more about this strategy, including how you could use it to collect $1,200 or more each month from the stocks you own, follow this link.