QUESTION: Aside from getting some protection against a further drop in the US dollar, why should generally conservative, long-term investors add some foreign exposure to their portfolios?

ANSWER: The 20th century was the clearly one of American economic dominance. That won’t change overnight. But the world economy is now going through a transformation, the outcome of which will be a change in economic growth leadership. The expectation is that this leadership will be assumed--in due course--by the East (i.e., Asia).

The process won’t be a smooth one and it’s irreversible. Successful investors, both large and small, will have to take this into account when making asset allocation decisions for years to come. That’s incidentally the central tenant of my book The Silk Road.

QUESTION: What countries are the leading beneficiaries of the rising East?

ANSWER: One of the most obvious is Russia. The country is clearly in the sweet spot as a natural energy exporter to Asia as well as Europe. Most people know it's a net oil exporter and that its economy has grown rapidly in recent quarters. What’s less widely known is it’s no longer dependent on foreign capital flows, as it was in years past. In fact, it has a USD236 billion in surplus foreign exchange reserves. That’s on top of more than USD50 billion in its oil reserve fund.

QUESTION: Russia has recently tried to change the terms of foreign involvement in its oil industry. What assurance do investors have they won’t face a similar “renegotiation” to their detriment?

To be sure, no one is willing to say that Russian practices have changed overnight--far from it. On the other hand, things are looking much better and positive news can easily continue to come out from Russia for years to come. In any case, the market boasts reasonable, if not cheap valuations, so basically the growth story outweighs the risk.

Russians seem to be confident once again, and the country is now more open to doing business with, and learning from the rest of the world.

These factors were lacking in previous cycles. As an aside, note that this cooperation doesn't include selling Russia's natural assets to foreigners or their local representatives, as previous “advisors” had once counseled.

Of course, President Vladimir Putin is credited with making the changes necessary for Russia to advance. And in view of the disaster of the Yeltsin years--essentially a lost decade--when Russia had no direction and no clear vision of its future, Putin’s leadership shines even more. The fact is the country is more stable politically than it’s probably ever been.

QUESTION: Isn’t this favorable growth story really dependent on energy prices? What happens if, say, oil gets knocked for a loop?

ANSWER: Although Russia’s good fortunes are a consequence of higher energy prices, stemming from strong economic growth in Asia and geopolitical instability, the fact of the matter is that its government has acted responsibly, seizing the opportunity to improve Russia’s position in the world stage.

The government runs a fairly conservative fiscal policy while inflation has been steadily decreasing and could fall below 9 percent sooner rather than later. Russia recently paid off all its bilateral foreign debt (USD22 billion in face value) to the Paris Club, an informal group of official creditors whose role is to find and coordinate sustainable solutions to the payment difficulties experienced by debtor nations. Consequently, Russia will no longer be a Paris Club debtor, while remaining a major creditor within the Paris Club. The Russian move represented the largest prepayment ever made to Paris Club creditors.

The solid performance of the economy has also led the Russian government to proceed with the convertibility of the ruble as of July 1. Currently, Russians and foreigners are able to take rubles abroad, foreign investors are allowed to open ruble bank accounts and restrictions on fixed-income and ruble-denominated investments have ceased.

Although the domestic market is still quite small for this change to have any major impact, the point to note is that the investment process for Russian companies will now be more efficient, as they'll be allowed to source funds in rubles. It's expected that the ruble will strengthen, perhaps trading closer to 25 rubles per USD1 by year's end.

As economic growth in China, India, Vietnam and the rest of Asia continues, Russia’s position as a growing economy is also secure.

And, of course, it’s not only Asia but also Europe and others that are now recognizing that Russia should be taken seriously once again.

Case in point: Russia recently hosted--fairly successfully--the Group of Eight (G-8) meeting in St. Petersburg. In the process, it made substantial progress toward securing its own economic development.

Regardless of personal views on the specific issues raised during the G-8 summit, Putin came to the negotiating table with an energy deal other leaders couldn’t refuse, no matter how much they wanted to. Clearly, Russia warts and all is a source of stability in energy and a more desirable energy partner than, say, Saudi Arabia or Venezuela.

QUESTION: What about Russia’s relations with the US?

ANSWER: Mr. Putin may have been employing his now-famous wit to describe at least the US posture toward his country when he recently referred to his counterpart during a joint press conference as, “My friend, the president of the United States, George W. Bush.” At the same time, though, the two countries have managed to find common ground regarding several issues.

A good example is the joint US/Russia announcement of a deal to cooperate on civil nuclear programs. The statement addressed, among other things, the creation of “a system of international centers to provide nuclear fuel services, including uranium enrichment, under (International Atomic Energy Agency) safeguards.” Putin said the idea was to create a system that gives all states access to nuclear power while it guards against the proliferation of nuclear weapons.

The first center would be in eastern Siberia.

It goes without saying that it will take time for such a deal to come through. But this is a groundbreaking idea. If successful, such a system would bring the US and Russia closer together and could help defuse some of the world’s problems.

True, the US negotiators weren’t persuaded by their Russian counterparts to consent to Russia’s entrance into the World Trade Organization (WTO). But this is a secondary issue for Russia right now, as its two main industries--energy and defense--have nothing to do with the WTO. The WTO can wait while Russia continues to put its house in order, strengthening its economy and eventually its negotiating power.

QUESTION: How should investors buy into Russia?

ANSWER: I advise looking at long-term growth stories, particularly energy. A global recession, choppy market or commodities bubble would no doubt hurt this sector as well as the rest of Russia. But the country continues to modernize and improve its economy and perform well while doing so.

My favorite play is GAZPROM (OTC: OGZPY), often referred to as the "state within the state." Accounting for 8 percent of Russia's GDP and about a fifth of the state's tax revenues, it’s rapidly becoming the world’s gas company.

True, a lot of problems will need to be gradually resolved for the company to realize its true potential. It’s been a priority of the Putin administration not only to take control, but also to do everything possible to clean it up, at least by Russian standards.

Gazprom continues to suffer from a bloated cost structure, a legacy of the Soviet years and their aftermath in the lost decade of the Yeltsin years. Many insiders still take their cut, as noted in an annual report on the company published by Hermitage Chairman Bill Browder, one of the most successful Russian-based money managers.

Browder had his Russian visa revoked last November. It's rumored that his Gazprom report caused the revocation. I claim no inside information, but I have no problem believing this may actually be true. Some habits, after all, do die hard. The fact is that a lot of high-end lobbying is underway to get Browder back inside Russia.

Even United Kingdom Foreign Secretary Jack Straw is rumored to have been involved.

Nevertheless, there's been some progress on the matter, although my expectation is that it will be Putin who will need to eventually interfere, hopefully by supporting Browder’s case. The good news is the economic and investment communities have warmly received the new Gazprom CEO Alexei Miller. In addition, the company is flush with cash, and the latest quarterly profits are up by 25 percent.

But Gazprom isn’t a simple energy company. Its ownership of vast gas reserves and its size allow it to close strategic deals that are turning it into the most important player in the industry.

QUESTION: What about the company’s relationship with the rest of Europe?

ANSWER: Gazprom already supplies a quarter of Europe’s gas; and that share will only increase. Recently, Gazprom and Algeria's Sonatrach agreed to work together on liquid natural gas (LNG) projects and jointly bid on foreign projects. Algeria already supplies 15 percent of Europe’s gas. So a strong alliance between these two suppliers would be a formidable force in what’s already clearly a sellers’ market for energy.

Different countries in Europe are dealing with the new reality in diverse ways. On one hand, there are countries--like Italy--that haven’t been able to adapt to the changes very well. Italy imports 80 percent of their gas, with 32 percent coming from Russia and 37 percent from Algeria. Evidence points toward an eventual gas deal with Russia and more cooperation between the two nations in the future.

Germany, on the other hand, is on the opposite end of the energy spectrum. The country’s previous leadership understood that cooperation with Russia isn’t only inevitable, but desirable as well. Former Chancellor Gerhard Schroeder was the architect of this relationship. The most obvious benefit so far is a new gas pipeline that will run from Russia straight to Germany’s Baltic Coast, conveniently bypassing the Baltic States and Poland.

Schroeder is now the head of the Gazprom-controlled consortium that will build the pipeline. Schroeder’s move means that Germany has a strong lobbyist inside the most powerful gas company in the world.

MARKET WATCH

Lower interest rates and another drop in energy prices were the key trends affecting income investors this week. Both were a response to more signs that the economy may be slowing.

On the one hand, falling rates are generally positive for yield-paying investments. But with energy falling and economic concerns rising, there’s been a considerable divergence between sectors.

Bonds and most preferred stocks, for example, turned in a mostly solid week. Dividend-paying telecoms were another group that held its own.

In contrast, utility stocks had a very up and down week, posting large down days before today’s recovery. The same was true generally for real estate investment trusts.

Canadian royalty and income trusts, however, had a much rockier time. Energy isn’t the only industry in Canada, but it is the most important one and it tends to set the tone for everything else. And while there were some solid individual performances from trusts that make their living outside the oil patch, more than a few lost ground.

The worst-hit were, of course, oil and gas producer trusts, particularly those that trade NYSE and therefore have the greatest visibility in the US. Widely-held ENERPLUS (NYSE: ERF), for example, has now lost more than 10 percent from its recent high in the upper 50s. That has nothing to do with any performance at the trust, simply that prices had risen to lofty levels and investors are punishing the shares due to fears about the future of energy prices.

As my colleagues and I have been writing, every long-term bull market in energy is punctuated with selloffs. That was certainly the experience from the period of the 1970s, the last real bull market.

The industry itself has been talking about the possibility of a selloff for some time and most companies seem prepared for it.

A potentially nastier situation seems to be shaping up with natural gas prices, which are again slipping and sliding down towards $5 a barrel. If they take out that level and go lower, we could see a panic in the producer stocks, particularly smaller and weaker ones.

Even the stronger ones would likely pull back sharply, despite the fact that they’re quite cheap already. Fast-growing CHESAPEAKE ENERGY (NYSE: CHK), for example, is off 25 percent from its recent high and trades at a single digit price-to-earnings multiple.

If there’s good news for energy now it’s that this selloff has nothing really to do with the long-term bull case. Basically, until there’s real conservation, a move to alternatives like nuclear power, a genuine discovery of quality conventional oil and gas reserves like the North Sea of the ’70s and probably a recession of early ’80s severity, the underlying supply/demand balance for energy will remain squarely in the hands of producers. It took a combination of all of these factors to end the energy bull market of the ’70s, and none are in evidence today in any meaningful way.

On the worrisome side, even during the ’70s there were corrections in energy that hurt investors who bought too high, panicked out when things went awry or were holding the most leveraged producers. That will be the case this time, and the further prices fall the worse the damage.

Accordingly, my advice remains to stick with quality. In energy, that’s producers who can weather the downturn thanks to financial power, a solid base of reserves and the ability to control operating costs.

As I wrote last week, I count super oil CHEVRON (NYSE: CVX) in that category. I also count the strongest Canadian royalty and income trusts, solid small producers like Chesapeake and utility/producer favorites like DOMINION RESOURCES (NYSE: D). I don’t count small explorers, tiny trusts and any penny stocks the promoters have been pushing for well over a year.

Any downturn in energy now will be more than made up for with an explosive recovery. But not everything that’s high now will make it through the cycle. Make “high quality” your watchwords if you want to play in this volatile game.