In many ways, Brazil offers some of the best prospects among emerging markets and deserves to be a core holding in any international portfolio.
Brazil's economy had only a shallow recession and is now recovering nicely. Its market has been one of the best performing since Dec. 31, 2008, and both inflation and the budget deficit remain under control.
Yet one can be only moderately bullish - and I'll explain why.
If you rely on the numbers, Brazil appears to be in fine shape. Its gross domestic product (GDP) declined by just 0.3% in 2009, and is expected to rise by 5.8% in 2010. Its balance of payments deficit is less than 2% of GDP and its budget deficit, at less than 4% of GDP, is very moderate. Inflation is also moderate at 4.6%, and short-term interest rates at 8.5% are high enough to keep the inflation under control.
What's more Brazil is about to start benefiting from a gigantic oil find, the huge new Tupi oil fields, where oil was confirmed in 2007. These are located below heavy salt beds in deep offshore water, up to 7,000 meters down, much further than had been possible to drill until recently. These enormous discoveries appear to contain at least 60 billion barrels of oil, worth $4 trillion at today's prices. They are expected to come on stream starting in 2012 and will revolutionize Brazil's economy and its balance of payments.
While Brazil's stock market has zoomed up in the last year, it is currently selling at only 16.6 times earnings, well below its counterparts in both India and China and a reasonable valuation, given the growth prospects.
Unfortunately, there's an election late this year. While incumbent President Luis Inacio "Lula" da Silva can't run again, he wants to pass his power on to his party's nominee -former Chief Minister Dilma Rousseff. Rousseff was put in charge of devising a scheme to capture more of the Tupi oil revenue for the Brazilian government and, nominally, the Brazilian people.
A new state oil company, Petrosal, will be created to manage the new reserves. Petroleo de Brasileiro SA (NYSE ADR: PBR), also known as Petrobras, will carry out production, with outside investors helping to supply the capital. Output will be shared between the investors and Petrosal. Petrosal will have half the votes on the operating consortium and veto rights over production and capital expenditures. A new state fund will be set up to manage the revenue, which will be devoted to poverty relief, education and infrastructure.
Meanwhile, the current royalty system would remain, so that outside investors would pay both royalties and a production share. As one concession to reality, the concessions already granted would not be torn up.
There are two major problems with this system. First, it makes life much more difficult and less profitable for oil companies wanting to invest in the Tupi fields. Second, the oil revenue fund will be a huge pool of money for politicians to play with. Brazilian public spending is already 35% of GDP - a very high rate for such a poor country.
State bureaucrats have featherbedded contracts guaranteed to them under the 1988 constitution. So this slush fund will just fuel Brazilian corruption and divert yet more of the economy into the pockets of politicians, and to their friends and favored interest groups.
That makes Brazil dangerous from a long-term vantage point. If the state petroleum fund allows the already-outsized government to expand, Brazil will slip back to its 20th century state of forever being the "country of the future."
On the other hand, the petroleum fund could do enormous good if it is mostly channeled into tax cuts so that the state accounts for a smaller part of larger economy.
We will know much more about Brazil's long-term prospects after the election, due in two rounds in October. In the meantime, rapid growth in China and India and expansive monetary policy in most of the developed world are causing a prolonged commodities boom, which can only be good for Brazil's economy.
So at least part of your international money should be invested here, despite the stated risks.
Brazil's prospects are simply too good to miss, even with the doubts attached. Here are what I believe to be the six best ways to capitalize on Brazil's promise, and the global trends that are feeding it:
Editor's Note: Looking for an unusual way to profit from the Brazilian economy? Our research team has unearthed an opportunity to begin pocketing as much as 2,840% gains... before the next market correction. It has to do with one tiny mining company - and one enormous discovery. The company has found an estimated $49.2 billion worth of the most strategic metal on earth today. It's not gold or uranium. Bottom line: The discovery could help to replace $10.4 trillion in oil profits, while powering the global economy of the future. Go here for the full report.
To find out how soaring demand from the U.S., China, Brazil and others is about to send shares of this obscure company soaring... please go here now for the full report.