How to Profit From Chile, Latin America's Real Economic Powerhouse

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By Jason Simpkins
Managing Editor
Money Morning

Brazil is often thought of as the best, if not only, investment play in Latin America, but Chile – with its equally abundant resources and sound fiscal governance – is emerging as an impressive economic rival.

In fact, Moody's Investment Service last month raised Chile's sovereign debt rating to A1 from A2. Chile is the only investment-grade country to be upgraded by Moody's since the financial crisis began almost two years ago. The ratings agency also boosted the foreign currency ratings of four major Chilean banks.

There are two reasons why Chile's economy, while not exactly vibrant at the moment, has caught the eye of Moody's and a growing throng of investors. The first is the nation's rich copper reserves. And the second is Chilean Finance Minister Andres Velasco, who had the foresight, long before this crisis ever started, to set aside $48.6 billion – more than 30% of the nation's gross domestic product (GDP) – that is now being used for tax cuts, subsidies and other government programs.

Velasco, who was one of the most-hated men in Chile as he squirreled away the country's huge copper profit in the last boom cycle, is now President Michelle Bachelet's most popular minister, Bloomberg News reported.

After earning a bachelor's degree in philosophy and economics in 1982, Velasco graduated from Yale University in 1984 with a master's in international relations and received a doctorate in economics from Columbia University in 1989, Bloomberg reported, citing Velasco's resume.

Velasco taught economics at New York University and then at Harvard University, where he worked with Lawrence Summers, now President Barack Obama's National Economic Council Director.

"In this world, there are some people who are smart. There are some that are practical," Summers told Bloomberg. "Andres Velasco is both."

Chile had less than $6 billion in treasury holdings when Velasco took over as finance minister in March 2006. By the end of last year, the central bank had an astonishing $48.6 billion at its disposal.

About $22.7 billion of those holdings were placed into two sovereign wealth funds. And the central bank has roughly $23.2 billion in international reserves.

At its peak last year, the price of copper had almost tripled from 2005, and both President Bachelet and Velasco came under intense public and political pressure to spend the magnificent bounty being wrought by Chile's state-owned copper giant, Corporación Nacional del Cobre de Chile (Codelco). Codelco is the world's largest copper producer and it provides roughly 15% of the country's revenue.

But Velasco was determined to adhere to "prudent fiscal policies" and break the commodity-driven trend of boom and bust that had plagued the nation.

"That is a cycle that needs to be ended," Velasco told Bloomberg. "We have been out to show that a Latin American country can manage properly, and not mismanage, a commodity cycle. You have to save in times of abundance, and you invest in lean times."

Chile's prudence and its stockpile of reserves now give Velasco flexibility in dealing with the current economic crisis. President Bachelet earlier this year unveiled a $4 billion stimulus package that included subsidies, tax rebates, and a boost in infrastructure spending.

Bachelet said the plan aimed to create 100,000 jobs, would increase public spending by nearly $1.5 billion, with $700 million of that destined for public works projects. It also included cash handouts of about $70 (40,000 pesos) to 1.7 million poor families and a $1 billion capital infusion for Codelco.

The new measures follow a separate $1.15 billion stimulus package the government unveiled in November.

Chile's central bank has cut 650 basis points from the country's key interest rate this year, taking it to 1.75%.

The International Monetary Fund predicts economic growth in Chile will reach 0.1% in 2009 before accelerating to a 3.0% year-over-year gain in 2010. That tops internal estimates of a 0.5% contraction this year, but in line with the central bank's projection for 2010.

"I don't think there's a single economy in the world where the country's credit was upgraded and the next day the major banks in the country were upgraded, where between the central bank and the treasury you have almost a third of GDP in liquid assets and where you can pump up fiscal policy and have country risk go down, not up," Velasco told the Financial Times.

Chile's Copper Gold Mine

As capable as Velasco has proven himself to be, the large deposits of copper found within the country's borders are equally responsible for Chile's enviable financial position.

From March 2005 to March 2006 – when Velasco took office – the price of copper had rose by more than half, soaring to $2.25/lb. And by the summer of 2008, copper prices had peaked above $4 a pound, bringing a tremendous amount of revenue to the Andean nation.

As stated earlier, Chile's state-owned copper giant, Codelco, accounts for roughly 15% of the nation's revenue.

Of course copper prices came crashing down with just about every other commodity as the financial crisis obliterated global demand, and tested lows of $1.25 a pound in December.

Since then, however, copper prices have made an impressive rally, leading Chilean Mining Minister Santiago Gonzalez to proclaim that prices of $1.25 for the metal are "in the past."

Copper prices rallied 31% in the first quarter, as huge purchases from China compensated for sluggish demand elsewhere.  Last year, China introduced a $585 billion economic stimulus package that focuses primarily on infrastructure development. Additionally, the Asian nation is attempting to stockpile many key commodities while prices are low.

China supplanted the United States as the world's largest consumer of copper in 2002 and buys one-third of its copper from Chile.

"China is buying large amounts of copper," Gonzalez said. "That's part of copper's recovery."

Chinese refined copper imports surged 138% in March from a year earlier to 296,843 tons, according to China's General Administration of Customs. Copper imports for the first quarter climbed 92% year-over-year to 748,281 tons.

"[April] copper purchases to be even higher," Sheng Weimin of Wanxiang Resources told Forbes. "Momentum may only cool if scrap imports start to rebound significantly from May."

China's purchases have been influenced by a shortage of scrap copper. Scrap copper is the second hand copper that is fielded by so-called urban miners. With many construction projects dried up, the supply of scrap copper has contracted, forcing China to buy more of the metal directly from mines.

"I'd guess as much as 80% of the high-end scrap market has disappeared since last year," Carlos Risopatron, head of environment and economics at the United Nations-linked International Copper Study Group, told Reuters.

Scrap copper accounted for about one-third of the world copper market in mid-2008.

Regardless of whether the rally can be sustained in the short-term, analysts point to the global trend of urbanization and growth in electric energy generation in emerging markets as positive for the industry.

"Cheer up, there's no need to cry in your beer," Robert Friedland, president of Ivanhoe Nickel and Platinum, said at the annual CRU/CESCO copper conference in Santiago. "The pace of urbanization and electrification will overwhelm this crisis."

"The winners of this game will be Chile, Mongolia and Congo," Friedland said.

Money Morning Contributing Editor Martin Hutchinson agrees. On April 2, he praised Chile's turnaround, and its future prospects, in a column entitled "Chile: The One Country That Was Prepared for the Financial Crisis"
According to Hutchinson, some of Chile's most attractive companies include:

  • CorpBanca (ADR: BCA): Only Chile's fifth-largest bank, but it's most consistently profitable.  Most Chilean banks suffered in the last quarter of 2008 because of the peso's decline against the dollar, but CorpBanca was properly hedged and avoided this problem.
  • Lan Airlines S.A. (ADR: LFL): Normally I'd suggest you were mad to invest in an airline (a business that has lost money worldwide over the entire 106 years since the Wright Brothers took off). However Chile's long thin shape, remoteness and abundance of mountains make air travel both within the country and internationally a profitable business. LFL is currently on a P/E ratio of 9 times with a 13.8% dividend yield. Not a "widows and orphans" stock but well worth a little investment for the adventurous.
  • Madeco SA (ADR: MAD): Manufactures all kinds of household goods and other products based on copper, aluminum and other non-ferrous alloys. Madeco had a special gain in 2008, so its annual earnings were artificially high. But it currently trades at about 6 times 2007 earnings and 40% of book value, with over $200 million in cash. Basically, this is a deep-value asset play.
  • Vina Concha y Toro S.A. (ADR: VCO): I can't help it. I like the product – Chile's largest wine producer. Chile was the only country in the world whose grapes were not infected by the Great Phylloxera Blight of 1873. Wine snobs therefore claim that Chilean wines, being made with pre-Blight grapes, are the best in the world. The market seems to buy this sales pitch, since the stock trades at 18.6 times earnings, distinctly pricey in these markets. Still, if you don't buy the stock you should at least try the wine!

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