The US Treasury’s historic bailouts of Fannie Mae, Freddie Mac and American International Group have rocked the world over the past few weeks. And with other regional banks and investment houses teetering, there’s almost surely more turmoil to come.

The market’s initial reaction has been intensified worries about the global economy. The longer-term impact, however, is a lot of money is being pumped into the system. That’s ultimately bad for the US dollar and great news for one of VRI’s cornerstone investments: gold.

The yellow metal has already responded, decisively breaking the downtrend and rebounding toward $900 an ounce. That’s lit a fire under our three VRI Portfolio gold positions: major miner Goldcorp (NYSE: GG), far more leveraged producer Lihir Gold (Australia: LGL, NSDQ: LIHR) and streetTRACKS Gold Trust (NYSE: GLD), the exchange traded fund that’s a proxy for the metal itself.

The best is yet to come. As we’ve pointed out in past issues, gold’s fortunes are in virtually perfect opposition to paper currencies such as the US dollar. When the world’s printing presses are working overtime, paper loses value. And as the only store of value that governments can’t create by fiat, gold is the beneficiary.

As the graph “Gold and the Dollar” shows, the US dollar has been down trending for the past six years, and gold has been rising. The past few months have seen a reversal of the dollar’s fall, with a detrimental impact on the yellow metal.

We first warned about the likelihood of a dollar rebound and its negative near-term impact on commodity markets in the March 20, 2008, issue, Day of the Dollar and in the Aug. 15, 2008, issue, Gold vs. the US Dollar, in which we also discussed the euro/gold relationship.

Since May, events have pretty much played out that way. We’ve elected to hold our gold positions for three reasons. The first is our belief that the dollar’s rebound would prove to be a short-term correction in its long-term downtrend. Second, gold is the ultimate disaster hedge, as its sharp rise this week has proved.

Finally, as we’ve pointed out in the past, for gold to reach the same inflation-adjusted price it reached in 1980, it would have to rally pretty close to $3,000 an ounce. That’s never been our flat prediction. But it does illustrate that gold and gold stocks remain sharply undervalued in today’s market place, particularly considering the turmoil. And that means there’s a lot of potential upside for sticking through the ups and downs.

Our advice remains to buy all three of our favored gold positions. The most conservative bet is the streetTRACKS Gold Trust exchange traded fund (ETF), which is a highly liquid means to owning the metal. As a growing miner, Goldcorp enjoys some leverage to gold prices, so its moves should be greater than the metal’s. Finally, Lihir Gold is our most leveraged play. It suffered the most on gold’s pullback this summer but stands to benefit the most.

Buy all three at current prices, particularly if you’re light on them. The US dollar’s value is likely to gyrate wildly in coming months as events occur. But our picks won’t trade at these low prices forever.

As VRI readers well know, the Russian market has been hit extremely hard in the third quarter. The first blow came from oil’s drop over the past two months, which took a toll on all resource-heavy markets. Selling pressure intensified as the US financial crisis worsened, and investors lost appetite for emerging markets in general. And it’s been further magnified by the global political turmoil surrounding the country’s military conflict with neighboring Georgia.

Investors, however, are vastly underestimating the strong position of the Russian economy. First, the country is a net oil exporter that’s forecast to post 2008 GDP growth of 7.6 percent. The country doesn’t depend on foreign capital flows. It’s rather politically stable, boasts reasonable market valuations and, above all, enjoys solid exposure to the biggest growth story of our time, Asia.

Russia’s fiscal position is quite strong; neither the corporate sector nor the consumer is overly indebted. At the same time, the Bank of Russia, the central bank of the Russian Federation (CBR), has accumulated enough foreign exchange reserves–around USD600 billion–to give itself some serious maneuvering space. Furthermore, the majority of economists agree that the budget will remain balanced as long as oil prices are above USD50 per barrel, half the current spot price.

Finally, after the recent selloff, Russian stocks on average are trading at extremely low valuations of 6.5 times earnings. It all adds up to a massive buying opportunity for those who believe in our main conviction: that the resource cycle has a long way to run.

Mechel (NYSE: MTL) has been one of the long-term favorites here. We’ve recommended the stock in good times–occasionally advising to take some profits off the table–and in bad. And we continue to favor it. See VRI, 24 July, 2008, The Trade, Mechel and More.

Mechel is a leading mining player in Russia (57 percent of earnings) with a 100 percent vertically-integrated steel division (42 percent) and a growing power business (2 percent). The company is the largest coking coal producer and the third-largest steam coal maker in Russia. It’s also the second-largest long and specialty steel producer in Russia. And it’s the only vertically-integrated stainless steel maker in the world, a tremendous advantage over rivals in a world of rising raw materials costs.

The company also has a logistics division with three ports and its own rail operator. And it’s been expanding in the ferrochrome business–which is used in making ferroalloy–where it stands to become a serious player.

Mechel will be one of the big beneficiaries of the Russian government’s infrastructure plan, already being implemented to allow the Russian domestic economy to advance and wean itself off boom and bust cycles. The government will spend lavishly during the next 10 years in an effort to improve everything, from dams and roads to power plants and airports. New construction spending grew by 22 percent in the first half of the year.

Steel demand is already outstripping supply and the market should remain tight for sometime. Mechel is also benefiting from the high prices that coking coal commands as it remains one of the hottest commodities not only in Russia but globally. Coking coal supplies have been especially tight this year because of the massive flooding in Queensland, Australia–the world’s largest exporting region.

Mechel is also exposed to thermal coal and should benefit. Because the Russian coal industry is still in the early stages of modernization, demand has nowhere to go but up. As the chart below shows, thermal coal remains the primary fuel source for electricity generation globally, which should be the case for many years despite building regulation of carbon dioxide (CO₂) emissions. 

In Russia, thermal coal is only used for 17 percent of electricity production; therefore, the growth prospects are huge. Seventy-nine percent of electricity generation comes from coal in China, compared to 54 percent in the US. With the global average at around 40 percent, Russia demand will almost certainly increase for years to come. Mechel is planning to increase its presence in the Russian power sector and use its vertically-integrated power plants supplied by its own steam coal, thereby securing higher margins.

Concerns stemming from this year’s brief confrontation with the Russian government are arguably still hanging over the stock. Ironically, this is no longer a major concern. The principal ownership has mended fences, and the government is supportive of its growth efforts. Mechel is a buy at current prices.

Our second Russian recommendation is Norilsk Nickel (OTC: NILSY). The company produces 20 percent of the world’s nickel, 47 percent of palladium, 11 percent of platinum, 37 percent of rhodium, 13 of cobalt and 2.7 percent of copper. The company is self sufficient in energy, particularly hydro power.

As we’ve noted before, transportation is a problem for this company because the adverse weather conditions in its areas of operation—specifically the Russian Arctic—demands the best-available logistical support. See VRI, 27 December 2007, Tapping Russia’s Treasure House. As a result, it’s building its own fleet to carry resources. Its new container/cargo vessels traverse frozen seas without icebreaker assistance.

Norilsk is also operating through joint ventures with Rio Tinto (NYSE: RTP) in Chita, Russia, and BHP Billiton (NYSE: BHP). And the company is planning to develop a major coal deposit in the Norilsk region.  

We still recommend buying the stock, although we don’t see any near-term catalysts for recovery in nickel. See VRI, Sept. 11, 2008, Resources: The Long View. Nickel prices have been hit so hard that we don’t expect any further deterioration. And that should leave plenty of room for Norilsk to grow our investment.