The Russian stock market is cheap but faces a number of problems.
Russia, as Winston Churchill famously remarked, is a riddle wrapped in a mystery inside an enigma, and right now, investors will agree.
Barely a day passes without some analyst anointing Russia as the great emerging market opportunity of our times, or condemning it a corruption-riddled failed state to avoid.
Being Russia, it is probably both of those things, and a lot more besides.
High energy
You can see why investors like Russia right now. In an energy hungry world, Russia is king, or maybe Tsar. China can only dream of having its oil and gas deposits.
Better still, Russia has the political muscle to ensure these resources are used to its advantage. Global oil giants such as BP (LSE: BP) dance to its tune -- in, out, in, out.
It was hit hard by the credit crunch, but is recovering strongly. Industrial production is now just 4% off its peak before the crisis. Russia is more than a global commodity play, the domestic consumer is quickly becoming a force for growth. Retail sales are growing 5% annually, wages are rising, and unemployment is falling, down from 9.2% in January to just 6.8% today. Car sales rose 48% in July.
Russia is trading at a p/e ratio of just 7.7 times (some put it as low as 6 times), significantly below its long-term average nine times ratio. As I wrote in Battle of the BRICs, that's a lot better than rivals Brazil, China and India. Plus it is also in the running for the 2018 World Cup, and is England's biggest rival.
Everybody is talking about China, but Russia has outperformed it over the past 10 years. Who wouldn't want a piece of the biggest country in the world?
The smog of war
Well... there's the weather. This summer's record-breaking heatwave and wildfires have slashed an estimated £9 billion from economic output, slowing the country's recovery, and that doesn't include the cost of rebuilding homes.
Another £3 billion will be sacrificed as the government bans wheat exports following this year's disastrous harvest.
Russia may have been relaxed about climate change, no doubt dreaming of how much oil it could discover in a thawing Siberia, but this summer's record-breaking heatwave shows it isn't immune.
Its budget deficit is currently 5% of GDP, which the Russians hoped to cut to 2.9% by selling minority stakes in oil companies, banks and transport groups.
Corruption is endemic, the oil price is going nowhere right now, and relationships with the West remain frosty. Intelligence analysts claim the level of Russian spying in London is the same as at the height of the Cold War, although judging by the recent spy scandal starring the sleeper agent Anna Chapman, not quite as efficient.
All this and Bono too
Fund managers are hopping up and down about Russia at the moment.
Elena Shaftan at Jupiter Emerging European Opportunities says with unemployment falling and wages rising, the feelgood factor is returning to the country's domestic economy. Food retailers, food producers and banks should all benefit from growing consumer confidence.
Companies have also been restructuring their balance sheets and extended debt maturities, which should help them survive any future liquidity squeeze.
Shaftan likes Russian banks, but is less keen on commodities. She believes energy, metals and miners have little upside, while oil and steel producers are facing an increasingly tough tax regime. Her fund, which is 57% invested in Russia, has big holdings in Russian bank Sberbank, Lukoil, Rosneft and Gazprom.
Shaftan notes that Prime Minister Medvedev is continuing to crack down on corruption and bureaucracy, and is looking to improve relations with the West. He started this week, by having a cup of tea with rock star Bono.
Her fund is up 25% over the past 12 months, and 43% over five years.
Go East, young man
Douglas Helfer at offshore fund HSBC GIF Russia Equity is also confident, with the country's GDP is expected to grow more than 5% this year. Inflation has fallen to 6%, the lowest level since the Soviet Union collapsed, and interest rates were cut to 7.75% in May. They are now expected to remain steady, as the recovery picks up pace.
He says rising food prices are the biggest threat, although fears that this year's disastrous wheat harvest could lead to food shortages have been overplayed.
Like Shaftan, he is putting his faith in Russian consumers, investing in financials, property and retailers. Sberbank is also his major holding, due to its dominant share of Russian corporate and retail banking markets. His fund is up 22% over the last year.
Mother Russia
Investing in Russia isn't for the faint-hearted. Its demographics are dreadful. The authorities are so worried about the nation's drinking habits that they have just slapped a ban on vodka sales after 10pm.
The country's commitment to democracy is less than robust. It still longs to regain control over former Soviet satellite states and Medvedev recently punished Belarus over an unpaid $200m gas bill by ordering Gazprom to cut off supplies. Plus it has a history of making life difficult for itself.
Those are the risks. But if Russia continues its transformation into a successful modern nation, Russia could be the mother of all emerging market opportunities.
More from Harvey Jones:
> Harvey owns shares in BP.
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