Buy, Sell or Hold: Brazil's Petrobras Will be Poised for Big Gains When the Economic Recovery Kicks Off in Earnest

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By Horacio Marquez
Contributing Editor
Money Morning/Money Map Report

On October 27 of last year, as the market was beaten down in a stampede of panic selling, I realized that it had gone too far in its pessimism with respect to the future of the global financial markets and I recommended the iShares MSCI Brazil Index Fund (NYSE: EWZ).

At the time, the global financial system and the global economy were in a royal mess of proportions not seen since the Great Depression. Many of the major banks in the United States and Europe were in even greater disarray than they are now. With the credit markets totally frozen, consumers, companies and countries that had been caught overextended in their financing and with little or no cash reserves struggled to refinance their debts. 

This tightness paralyzed many of the sectors that rely heavily on financing, like capital equipment, autos, and others. In that manner the financial crisis exposed, and subsequently crushed, those industries that for decades failed to restructure and become competitive – just as we’ve seen with the recent turmoil surrounding the U.S. auto sector.

But I believed then, as I do now, that Brazil has made huge strides from the debt-ridden, top-heavy, bureaucratic government of its past. Brazil restructured its finances long ago and resisted the temptation to use crises in neighboring Argentina and in other places to default on its obligations. 

The Latin American nation now runs one of the most orthodox monetary and fiscal policies in the world, and its highly capable central bank and fiscally disciplined government have maintained fiscal and trade surpluses during the entire episode of global synchronic growth and high commodity prices.  The very high level of real interest rates avoided overheating the economy and creating an over-expansion of credit, which today would have ended terribly.

The decades-long policy of weaning itself off of imported oil by starting its own ethanol program and focusing on deep-sea drilling have helped Brazil achieve a remarkable level of self-sufficiency in the energy sector. And that self-sufficiency really paid off when oil had its massive spike up to $150 per barrel last year:  The country’s savings made it a net creditor of the world. 

So, Brazil – unlike the United States, England and much of Europe – was not over-levered. It was well positioned fiscally, and from an oil dependency standpoint, well equipped to face the dramatic events of last year. 

As a result, the market has valued Brazil’s consistently prudent policies highly. In the four days after my October 27 recommendation, the MSCI Brazil Index fund shot up 31% as investors realized how cheap high quality Brazilian equities were trading and forced liquidation abated. 

The ETF dropped back on some profit taking, but since mid-November, has brutally outperformed the S&P 500 by 37%. 

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What We Can Learn From Brazil

We, in the more developed nations, could learn a thing or two from the Brazil about consistent fiscal and monetary prudence, balanced and diversified trade, and self-sufficiency in energy.  And those universally valid principles should continue informing policies around the world today.

And in these crises, it is time to carefully select the very best companies – those with rock-solid balance sheets, superb management teams and sustainable competitive advantages that will survive over the years.  This is precisely the very best moment to start owning them with a long-term view, regardless of short-term volatility.

You see, during the generalized Asian crisis of the late nineties, the entire region saw their financial systems blow up in similar fashion.   But the enduring lesson from Asia and other emerging market crises was that every single country made it back – regardless of economic policies.  The difference in economic policies directly influenced the speed, strength and sustainability of their respective recoveries, but each economy did eventually resume its growth. 

Another major lesson was that, even though the strong companies and markets all suffered price-wise, the stronger companies and markets suffered less and recovered much faster than the weaker ones, which sometimes blew up and disappeared.  Hence, Brazil’s position of strength puts it right in line for a strong recovery. 

Also working in Brazil’s favor is the huge amount of money that the Federal Reserve and the Treasury Department are pumping into the U.S. economy, which, given its unparalleled flexibility amongst the Western economies, will post the quickest recovery. 

This large-scale debt issuance and money printing will eventually result in lower purchasing power for the U.S. dollar, which is already beginning to fuel a commodities rally.  And Brazil – a huge commodities exporter – is perfectly positioned to take advantage of this.

Brazil is making very good use of its strong finances in order to deploy appropriate responses to contain and even reverse the downturn in its economy.  As I mentioned, this strength is not an accident, but rather the result of decades of careful planning and consistent policies to persevere in structural reform and key economic initiatives.

Petrbras: Brazil’s Power Play

That brings us to the best way to play Brazil, independently of just buying the index ETF: Petroleo Brasileiro (NYSE ADR: PBR) – more commonly referred to as Petrobras – and Vale (NYSE ADR: RIO), which I highlighted back on October 27

Brazil’s policy of energy self-sufficiency achieved a resounding victory last year.  But there is much more ahead:  Brazil is on its way to becoming a major oil exporter.  And we are going to profit from it greatly.

Not only is oil going to rise strongly as soon as the major adrenalin shots of fiscal stimuli and massive monetary easing kick in around the world, but Brazil’s production is set to grow exponentially.  This double benefit which led President Luiz Inácio “Lula” da Silva to proclaim that God had given Brazil a second chance, will create billions and billions of dollars for Brazil through Petrobras, its leading energy company.

As my colleague Jason Simpkins diligently pointed out in his comprehensive summary of Petrobras’ massive offshore discoveries, the almost unparalleled Tupi and Carioca oil finds – together with the equally unparalleled Jupiter natural gas field – are a game-changer for the country.

Though, even with such an incredibly evident upside, there is always a catch to any bullish story. And in this case, some analysts believe that Brazil might resort to taxation or some other arrangement to minimize the upside for Petrobras shareholders and move that upside squarely into government hands. 

Others point to the huge costs of developing these extremely deep properties, the difficulty in transporting the oil back to land, the length of time involved in developing these fields, and even the difficulty of obtaining financing now that oil has sold off from $150 down to about $50 per barrel.

Of course, I resoundingly disagree with all these objections. And here’s why:

The Brazilian government, unlike those of Venezuela and Bolivia, has a long track record of welcoming foreign multinationals and individual investors and treating them fairly. 

Also, Brazil has been at the forefront of deep sea drilling for years. For example it has a 25% stake in the biggest U.S. oil find in decades: the Jack II in the Gulf of Mexico. And Petrobras actually anticipated the rush for oil by locking in long term contracts for every major deep sea drill rig that they could get their hands on ahead of the market.

Sure, it faces new challenges, but Petrobras – from ethanol to deep sea drilling – has proven savvy with its timing and consistent with its execution. 

Finally, as I had anticipated back in October, projects of huge strategic and financial significance will be a breeze to finance, even in very difficult market conditions.  Indeed, China which has been wisely using this crisis to cherry-pick access to commodities around the world, recently reached an agreement with Petrobras, in which China Development Bank will provide Petrobras $10 billion in financing in return for a long-term supply of oil.

We simply cannot pass on Petrobras With Petrobras ahead of a recovery in activity in the global economy and a devaluation of the dollar.

Petrobras rose 1.83% Friday to close at $35.17 a share. The stock is up 43% year-to-date.

Recommendation: Buy shares of Petroleo Brasileiro (NYSE ADR: PBR), using the current correction to average into this name on weakness over the next month (**).

 (**) Special Note of Disclosure: Horacio Marquez holds no interest in Petroleo Brasileiro (NYSE ADR: PBR).

[Editor's Note: Veteran Wall Streeter Horacio Marquez is the author of Money Morning's hugely popular "Buy, Sell or Hold" (BSH) series, and is also the editor of the longstanding "Money Moves Alert" trading service.

As the hundreds of thousands of readers across the Internet who've read Marquez's insightful BSH missives know, the longtime Wall Street insider has a knack for picking stocks that are poised to move. For a free report that details these ready-to-move plays please click here. The report is free of charge.]