Tags: Jason Simpkins, Latin America

Economic Carnival Cruises on in Latin America, Despite Sinking U.S. Market

By , Money Morning •

By Jason Simpkins
Associate Editor

The United States and Brazil parted ways last October.

In the 12 months before that, Brazilian stocks moved in the same direction as the Standard & Poor's 500 Index 90% of the time. But then that bellwether index for the U.S. stock index stumbled its way through last year's final quarter, and wheezed its way into the New Year, shedding 100-plus points, or about 7% of its value, along the way.

However, Brazilian stocks have rallied.

On Wednesday, the Bovespa index of the most-traded stocks on the Sao Paulo exchange gained 312.24 points, or 0.5%, to close at 65,494.85. Earlier that day, the index actually traded above its Dec. 6 record close.

With the U.S. economy wrestling with its worst housing downturn in decades, a massive credit crunch, an eviscerated greenback and even an outside chance for stagflation, this divergence is important for investors to note. An economic slowdown - or worse, a recession in the United States - was once the death knell for Latin American economies, which rely heavily on America as market for their exports. But the U.S. market seems to be loosing that grip as economies in Central and South America gather momentum from a global commodities boom and gain a more-diverse customer base for their goods.

While emerging markets, like those in Latin America, still lack the strength and economic independence to escape all the fallout of a trade partner's slowdown, and can't fuel global growth on their own, many of these markets are proving much more resilient and more economically self-sufficient than was previously believed.

 "No country can decouple from the U.S.," Kamal Nath, India's trade minister told The Wall Street Journal. "The question is the impact."

The United States accounts for 22.5% of the world economy. American consumers spent approximately $9.5 trillion last year, nearly six times as much as the emerging consumer classes in China and India, combined.

So when the United States, the leading importer of Latin American goods, struggled through a recession in 2002, it was no surprise when six of Latin America's most prominent currencies drop 20%.

Given that fact, many analysts were expecting a repeat performance when the U.S. housing market collapsed.

Instead, the Latin American markets seemed to step out of character and have turned in a bravura showing: Despite all the turmoil in the U.S. economy, the Latin American region has three of the four best-performing emerging-market currencies against the greenback.

Colombia's peso is up 7% on the dollar this year alone, and is up 56% against the greenback over the past five years. The Brazilian real closed at its highest level against the dollar in nine years on Tuesday, trading at 1.68 to the U.S. currency. It was the strongest close for the real since May 1999, when Brazil's government first floated the real against other currencies.

The Chilean peso and Peruvian nuevo sol are also up more than 3% this year and are trading at seven-year highs, Bloomberg News reported. Mexico's peso is up more than 1% against the beleaguered greenback.

The obvious question becomes: What changed?

The difference this time around is that a global rush into commodities of almost every type has attracted a new group of trade partners to the shores of Latin America, and the resource-rich region has used the higher demand and higher resultant prices to amass war chests fat with cash reserves.

"Latin America has far better economic policies and tremendous support coming from high commodity prices," Jonathan Binder, who overseas $1.7 billion of emerging market assets at INTL Consilium LLC, told Bloomberg. "The region will be resistant to the kind of risk correlated to the U.S. [that] people previously expected."

The Commodity Boom Brings Wealth to Latin America

Earlier this week, the price of oil and gold continued their record-breaking runs. Spot gold rose as high as $964.70 an ounce and crude oil for April delivery climbed above $102 a barrel for the first time. Oil has averaged $93.02 a barrel this year, up nearly a third over the 2007 average of $72.30.

Meanwhile, silver rallied to its highest level since November 1980. Palladium jumped to a 6-1/2-year high, and platinum gained 1.7% - edging ever closer to its record of $2,206 an ounce. Platinum has gained more than 30% in the last month alone.

Since 2001, gold has risen 255% - from $271 per ounce to $961 on Feb. 27. Silver has gained 290%, and platinum has jumped 256%.

Iron and coal, two ingredients central to the production of steel, have also seen their prices soar.
On Feb. 22, Brazil's Vale (RIO), announced that Chinese steelmaker Baosteel Group Corp., in negotiations on behalf of the Chinese steel industry, had accepted a price hike of 65% for iron ore. The move followed a Feb. 18 agreement between Vale and Japan's Nippon Steel Corp. and Korea's Posco (PKX), which also agreed to a 65% price increase.

Price negotiations for 2004 ended with an 18.62% increase, followed by a 71.5% rise in 2005 and a 19% increase in 2006. Vale, as the world's biggest iron ore producer, typically sets the benchmark for contract negotiations. But this year BHP Billiton Ltd. (BHP) and Rio Tinto PLC (RTP) have said they will likely seek even higher prices for their ore. Together Vale, Rio Tinto and BHP control 80% of the iron ore market.

The spot price of iron ore has tripled in the past five years and is currently hovering around $200 a ton.

Coal, which is responsible for 78% of China's energy output and 69% of India's total energy supply, has soared to record highs as well. The price of coal is up 37% already this year, analysts say. And that's after coal prices rocketed 73% in 2007.

GlobalCOAL's monthly index for Newcastle thermal coal prices rose $1.71 per metric ton, or 1.9%, to reach $90.87 in January, the fourth consecutive monthly record.

Soaring commodity prices have helped countries like Peru, Venezuela, Argentina and Brazil generate trade surpluses with their Far East trading partner, bolstering their cash reserves.

Non-U.S. Exports on the Rise

Trade between China and Latin America surpassed $100 billion last year, a benchmark the Chinese government didn't expect to reach until 2010. Commerce between the two regions totaled $102.6 billion in 2007, a 46% increase from 2006, according to Chinese government data.

For purposes of comparison, consider this: Last year, China's trade totaled $302 billion in the United States and $73 billion with Africa.

Brazil sent 6.7% of its goods to China last year, double the amount in 2001. Chile, Peru, and Argentina exported to China twice what they imported from their Asian trade partner. Mexico exported $3.2 billion worth of goods to China last year.

Speaking to bankers in Acapulco last month, Mexican President Felipe Calderon touted last year's increase in his country's exports to non-U.S. markets: Goods sent to the Middle East increased 48%, while goods shipped to Europe jumped 30% and those to Asia rose 25%.

The United States now absorbs less than 20% of the exports coming out of Brazil, Argentina, Chile and Peru.

On Monday, Brazil President Luiz Inacio Lula da Silva predicted that his country's economy would grow at least 5% annually through 2010.

"People are buying more and exports are growing because we don't depend on the United States, and Europe alone," he said. "Now we're exporting to many more countries around the world, and this leaves us calm in the face of an American crisis."

The government of Brazil recently made plans to establish a permanent commercial center in the United Arab Emirates to promote investment between the regions.  The UAE is home to the Abu Dhabi Investment Authority, or ADIA, a sovereign wealth fund with an estimated $875 billion in assets. Brazil is the world's sixth-largest economy and home to an internal market of approximately 190 million consumers.

The new center will serve as a permanent exhibition of products from Brazil and Latin America, and tap developing investment and marketing opportunities between the regions.

It will also enhance Arab-Brazilian relations through the presence of future Gulf investments in Brazil, Ahmed Yassine, president of the Trade Exterior Chamber of Brazilian-Arabian Gulf and North Africa, told the Emirates News Agency (WAM). Yassine led a delegation of Brazilian businessmen on a tour of the region.

"An estimated 20 million people of Arab origin live in Latin America and 7 million of them are in Brazil," Yassine said.

In 2007, Gulf countries imported $4.6 billion in goods from Brazil, an increase of 4.8% from 2006.

The amount of the region's debt denominated in foreign currencies fell to 24.7% of gross domestic product in 2007, down from 44.1% in 2002, according to the International Monetary Fund.

Latin America: Land of Riches

In the 1990s some emerging markets ran out of foreign reserves and defaulted on debt. But trade surpluses brought about by soaring commodity prices have resulted in a bounty of foreign reserves for emerging markets.

Emerging markets have an estimated total of $4.1 trillion in central bank reserves The Journal reported. That includes a cushion of $185 billion in Brazil, $49 billion in Argentina, and $80 billion in Mexico.

 "This time, we have something of a vaccine when the U.S. sneezes," said Claudio X. Gonzalez, chairman of Kimberly-Clark de Mexico SA.

Mexico's economy expanded by an unexpected 3.8% in the fourth quarter, as the U.S. growth slowed to a paltry 0.6%.

"This is going to be the first time in many years in which Mexico is going to move in the opposite direction as the U.S. business cycle," Alfredo Coutino, senior economist for Latin America at Moody's Economy.com (MCO), told Bloomberg in an interview.

"All global markets are correlated but over the year to date [to Feb. 6] Latin America markets have dropped 5.5% while the MSCI World has dropped 9.6%," Dean Newman, an equity fund manager at Invesco Perpetual Latin American, told Britain's Daily Telegraph. "We are not immune to the problems but the signs are that Latin America and emerging markets in general have been more resilient in the past."

"My perspective is that [Latin America] offers reasonable value. It is cheaper than some other emerging markets, certainly cheaper than Asia," he said.

Hot Investment Opportunities

According to Money Morning Contributing Editor Horacio R. Marquez, an emerging-markets specialist and Argentine native, there are a number of profit plays to be made throughout Latin America.

Marquez says investors should focus on Latin America's wealth of commodities [which are in demand in nearly every world market], and companies that profit from the region's growing middle class.

Here are just a few of Marquez's suggestions:

  • Petroleo Brasilero SA (PBR): Latin America's appetite for energy is nothing short of ravenous. As of now, three-fourths of the country's electricity comes from hydroelectric power. That figure will be higher in 2012, when the region's largest hydroelectric project, the Santo Antonio Dam, will begin producing electricity. Santo Antonio is the first of three Amazon River dams the government hopes will decrease Brazil's need for fossil fuels. Until then, however, Brazil's state-controlled oil-and-gas company, Petroleo Brasilero SA will continue to meet the demand.
  • Southern Copper Corp. (PCU): South America is stuffed with metals. And with commodity prices soaring, this is a good market to be in. As mentioned earlier, Vale is making a killing feeding China's appetite for iron ore. It's the second-largest mining company in the world, and the largest producer of iron ore and nickel. The Phoenix, Ariz.-based mining giant heavily taps South America's rich copper mines. Though based in the United States, this company has all of its mining, refining and smelting operations in Mexico and Peru. With this stock, however, investors are subject to the volatility of the U.S. market, which doesn't look very promising in the first half of this year.
  • The iShares Standard & Poor's Latin America 40 Index (ILF)/ iShares MSCI Brazil Index Fund (EWZ): Investors who are wary of investing directly in foreign companies have a few exchange-traded funds to choose from. The iShares Standard & Poor's Latin America 40 Index, which tracks highly liquid securities in Mexico, Brazil, Argentina and Chile, ended 2007 with a 44% gain. There's also the iShares MSCI Brazil Index Fund, a capitalization-weighted index that aims to capture 85% of the total market capitalization in Brazil. It invests in a sample of securities and is reviewed quarterly. Last year, it gained a healthy 72%.

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