I’ve long favored Russia as a destination for investment, building my case primarily around its energy sector. But I’ve also highlighted the increase in domestic demand and the infrastructure boom taking place there.

Russia is currently in a sweet spot: It’s a net oil exporter, has good GDP growth, isn’t dependent on foreign capital flows, is relatively stable politically, boasts reasonable market valuations and, above all, enjoys solid exposure to the biggest growth story of our time, Asia.

President Vladimir Putin, whose party won another electoral victory a few days ago, is credited with making the changes necessary for Russia to advance. The Yeltsin years, by contrast, were essentially a lost decade; Russia had no direction and no clear vision of its future.

Because of the changes Putin has pushed, Russians are confident and more open to doing business with and learning from the rest of the world. These factors were lacking in previous cycles. Note that this cooperation doesn’t include selling Russia’s natural assets to foreigners or their local representatives, as previous advisors had once counseled.

As a result the Russian market has easily outperformed the rest of the BRIC (i.e., Brazil, Russia, India and China) countries since 2000, as the chart below clearly demonstrates.

Source: Bloomberg

The above picture flies in the face of the rubbish eager politicians and their advisors have been feeding people about the beginning of a new Cold War. Heeding the expert opinions expressed during the past seven years in The Economist and other publications heralding an imminent Russia collapse would’ve cost you the huge returns the Russian stock market has generated for investors willing to look beyond smokescreens.

The economic interdependence between the growing Russian economy (now the eighth-largest in the world) and the West is increasing rather than subsiding. (See Growth Engines, 7 June 2007, Vladimir and Angela.) It won’t be a smooth ride, but cooler heads will prevail. Russian practices haven’t changed overnight; far from it. But things are looking much better, and the positive news should continue.

As long as Russia continues to grow and modernize its economy and its middle class increases in size and influence, its political culture will also increasingly reflect more Western-style characteristics.

Nevertheless, Russia remains open for business. Companies and investors that play by the local rules–as they must do in any other country they invest in–have not only profited handsomely, but have also established strong foundations for the future.

We’ve invested in Russia since Silk’s inception, and there’s still a lot of upside. However, expect short-term pullbacks given the precarious state of the global economy.

My favorite Russian companies, in order of preference, are as follows: LUKOIL (Russia: LKOH, OTC: LUKOY), Mobile TeleSystems (NYSE: MBT), OAO GAZPROM (Russia: GAZP, OTC: OGZPY), Vimpel-Communications (NYSE: VIP).

The Silk Roaders

A seasoned investor in the international arena sent me an e-mail the other day over the signature “A Silk Roader.” I found the term appropriate for Silk’s subscribers, providing a code word of sorts to a circle that’s still selective. Most investors haven’t yet grasped the economic transformation taking place in front of our eyes.

Asia is leading this great global economic transformation and will be the engine of growth for years to come. And the region ex-Japan is still enjoying a long-term bull market that commenced at the bottom of the 1998 Asian Crisis.

I’ve also received inquires regarding the upside potential for many Portfolio recommendations from investors trying to identify the next big winner. Occasionally, I will identify such plays. But the bottom line is I don’t play this game; fast guns are wasting their time with this publication as well as Asia and the rest of the emerging markets as an asset class.

The Silk approach remains one of gradual appreciation through the construction of a balanced portfolio that should be able to withstand the ups and downs of the marketplace, which is usually more pronounced in the emerging markets universe. The latter occurs because of the perceived risk of these economies as well as the relative small size of their markets.

This leads to the most talked about emerging markets issue, particularly with regard to Asia. Inquiring minds want to know whether we’re headed for a potential decoupling of Asian economies and markets from those of the most developed economies, particularly the US, where most of the economic problems can be found this time around.

Global markets have been synchronized for some time now, and it will take years for Asia to truly decouple from the US. That’s the general trend, but genuine decoupling will occur only after Asian economies are bigger and more assertive.

The rest of the world’s economies–led by Asia–have been able to sustain global economic growth to elevated levels since the US started losing steam in the middle of 2006. And if the US avoids recession, the rest of the world will continue to do so.

But if the current credit problems substantially damage the US economy, the world will feel the pain and economies will slow. Given their strong fundamentals, economies in Asia will be able to deal with such a blow much better than before and will subsequently bounce much faster off the downturn.

The long-term Asia story is founded on the economic reforms, moves toward privatization and commitment to free trade that emerged from the Asian Crisis. Asian governments and the region’s economic establishment have since been redefined.

The region’s companies have also been improving by shedding unprofitable businesses, paying down debt and enhancing management techniques.

Asian companies are generally cash rich, especially compared with the US-based companies. As the following chart demonstrates, cash on their balance sheets in some cases exceeds 30 percent of market capitalization.

Singaporean and Chinese companies are extremely strong in that respect. They can use this cash in a lot of ways, and they’ll have funds available to sustain them during bad times.

Investing in such strong companies during downturns means you’ll be able to buy solid future growth and strong balance sheets that will be penalized in a general downturn.

Source: Merrill Lynch

Portfolio Changes

I recommend selling Sanofi-Aventis (NYSE: SNY) as Silk portfolios continue to focus more on the emerging-market theme. Sell Sanofi-Aventis.

Looking Ahead

The month of December and the beginning of January will once again be dedicated to reviewing Silk’s portfolio positions and our investment themes. I’ll also take a look back at an exciting 2007.

I’ll introduce new themes, reiterate old ones and reveal our initial strategy for 2008, identifying companies you’ll need to focus on as we enter the New Year.

Fresh Money Buys

Because the investment process is constant, if you’d like to add to your positions in portfolio recommendations or allocate new funds in a diversified way, focus on the following markets (consult the Portfolio pages on the left of your screen for details), in order (for both countries and sectors):

• Singapore (banking, telecommunications, industrial)
• South Korea (electric power, banking)
• Hong Kong(real estate, banking, infrastructure, publishing)
• India (pharmaceuticals)
• Russia (energy, telecommunications)
• China (consumer, coal, e-commerce, oil, water, power)
• The Philippines (telecommunications, real estate)
• Malaysia (ETF)
• Taiwan (technology, telecommunications)
• Europe(industrials, communications equipment)
• Japan (banking, industrials)
• Macau (gaming)