goldman-sachs-favorite-emerging-market-for-2010The growth stories in the BRIC countries appear in sharp contrast to the view in developed markets, which are struggling to stabilize and reignite wide swaths of their economies; leading indices in Brazil, Russia, India, and China have all handily outperformed the S&P 500 ($SPX) in 2009. But only one country was singled out by Goldman Sachs (GS) macroeconomic and commodity analysts in a note to clients highlighting the group's "Top Trades for 2010" -- and that is the low organic growth, commodity-driven economy of Russia.

Citing a "still bullish long-term view on energy and the broader commodity complex," Goldman is targeting a 25% return from a U.S. dollar-denominated index known as the Russian Depository Index (RDX), of which three stocks -- Gazprom (OGZPY), Lukoil (LUKOY) and the oil company Rosneft -- comprise more than 50% of the weighting. In addition to oil and natural gas, the index also has companies exposed to steel, gold and nickel. Goldman estimates that oil prices will average $90 per barrel in 2010, which will allow a quick and healthy rebound in profits for Russian energy companies, leading to the stocks trading at a mere seven times forward earnings.

What's interesting about Goldman's preference for energy-levered Russian equities is that large-cap oil stocks actually underperformed relative to the price of crude during the last major run-up from roughly $60 per barrel at the start of 2007 to the near-$150 peak in the summer of 2008. The notable relative outperformance for the group came during the time when oil prices were plunging, during the fall of 2008. (The group of stocks I examined to draw this conclusion consisted of Exxon Mobil (XOM), Chevron (CVX), Occidental (OXY), Apache (APA), Anadarko (APC) and Gazprom. Lukoil was not tested because historical price data was unavailable.)

Two thoughts on this phenomenon: First, it is possible that oil stocks are similar to metal mining stocks in that they contain an embedded short call option. This theory says that the stocks of producers are better to own early in a bull market cycle, as they underperform during a period with a sustained rise in prices. Simply put, as higher prices seem more likely to become a permanent reality, end users find substitutes or do without, sapping demand and putting a downward pressure on prices. Another possibility is that the cycle is influenced by incremental new supply coming online, says macro hedge fund manager Chris Pia. Particularly with oil, $100 per barrel seems to be an important tipping point that brings about new supply.

Although retail investors can quickly make an allocation to Russian stocks through an ETF such as Market Vectors Russia (RSX), there's a more general reason to think twice before following Goldman on this trade: Russia does not have a rich history of upholding foreign shareholders' rights. And while Russian stocks will be cheap if oil prices surge, David Merkel writes, "The idea is to avoid situations where your rights as a shareholder might be ignored. It does not matter how cheap an asset is; if the ability of the asset to be liquidated is low, so should the valuation of the asset be low."

Goldman expects credit default swaps on Russian debt to trade down on lower perceived risk, but potential political and demographic problems in the country remain. Goldman's choice of Russia's energy sector as a top trade is more contrarian given the headwinds faced by Russia compared to other emerging markets, and that makes it more interesting than a momentum-driven play in Brazil or China. But overall, this seems like a second-derivative commodity bet in a politically volatile region with an upside roughly equal to owning crude oil outright.

James Cullen edits and writes at He is the vice president of the Boston College Investment Club, which owns GS and XOM, but has no personal position in those stocks.

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