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Have investors beaten up Russia too much?

Few, if any, asset classes are currently being vilified as much as Russian equities.

At the start of trading Tuesday, Market Vectors Russia ETF (RSX), the oldest, largest and most heavily traded Russia ETF, had plunged more than 40 percent over the previous 90 days as the ruble and oil prices tumbled.

And that was before U.S. markets had a chance to digest news out late Monday that the Russian central bank boosted its benchmark interest rate to 17 percent from 10.5 percent. Smacking of desperation and panic, the rate hike was the second since Thursday and in the span of less than a week Russian borrowing costs have more than doubled from 8 percent.

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However, the behavior of Russian securities, including RSX, is pricing in scenarios that are more dire than will actually come to pass. For example, the ruble's plunge implies Brent crude falling to $25 a barrel, a 58-percent drop from current levels. Additionally, some market participants are treating the Russia of 2014 as a carbon copy of the Russia 1998. That much is seen with the recent, exponential rise in default odds, which jumped to 28.5 percent on Monday from 20 percent on Dec. 8. Remember, that is for a country with $400 billion in foreign currency reserves and just $38 billion in dollar-denominated debt, a mere $6 billion of interest and principal payments is due next year.

Obviously, there is blood in the streets for Russian stocks and ETFs and maybe this exact moment is not the moment for contrarian bets on RSX. However, the veracity with which investors have punished Russian equities and the ruble could portend oversold and imminent capitulation that will give way to an impressive rebound for RSX.

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Of course, investors have heard it before, but Russian stocks are cheap. Russian shares are historically discounted relative to MSCI Emerging Markets Index, but those discounts are growing. Consider this: At the end of 2013, the P/E on RSX's underlying index was 7.2 compared to 11.8 on the MSCI emerging markets bench market. Those numbers are now 4.2 for Russia and 11.9 for the MSCI Emerging Markets Index. Russia's benchmark Micex trades at its widest discounts to the emerging markets stocks in nearly a decade.

Earlier this year, it was noted that OAO Gazprom, Lukoil and Mobile Telesytems, stocks that combine for 19.2 percent of RSX's weight, trade at an average discount of 40 percent to their 10-year average P/E ratios. Those discounts have since grown.

Russia is a massive producer of crude oil and crude oil never really goes out of favor, nor do any energies or grains for very long, so I think the opportunity for investors may be to get into Russia on the current down cycle in both energies and grains (wheat especially from Russia) since neither commodity generally stays out of favor for very long.

Against the backdrop of slowing economic growth, sky-high interest rates, a leaky currency a sovereign credit rating that earlier this year was lowered by Standard & Poor's to BBB-, the lowest investment grade, investors' skepticism toward Russian shares is understandable.

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Against the backdrop of slowing economic growth, sky-high interest rates, a leaky currency a sovereign credit rating that earlier this year was lowered by Standard & Poor's to BBB-, the lowest investment grade, investors' skepticism toward Russian shares is understandable.

No, a rebound in RSX will not be a free lunch. The ETF is volatile. RSX has a three-year standard deviation of 25.8 percent, or nearly 1,100 basis points above that of the iShares MSCI Emerging Markets ETF (EEM).

Oil prices also need to rebound to lend efficacy to the long RSX thesis. Oil accounts for roughly half of Russian government receipts, by far the largest percentage among the major non-OPEC producers.

Still, what looks like panic today could open doors to a new Russia tomorrow with the country's established, vibrant consumer and transportation sectors leading a bounce, with help from rebounding oil prices, of course.

Commentary by Tom Lydon, CEO of Global Trends Investments and editor and publisher of ETF trends. Follow him on Twitter @TomLydon.

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