Investing in the Americas - Outside View by Martin Hutchinson

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Investing in the Americas
Dec 10, 2010

Whether you win or lose on your Americas-related investments in 2011 will come down to a single factor - natural-resource prices.

If the prices of oil, gold, copper and other natural resources are high, the hideous flaws in the economies of a number of the countries north and south of the U.S. border will remain hidden behind, as if by magic.

But if resource prices plummet, then even some of the best-run countries in North and South America will probably stumble a bit - and several will be revealed as true economic basket cases.

When we refer to "the Americas," we're talking about all the countries in North, Central and South America - with the United States excluded. There's a great divergence in potential. So let's begin our journey with Latin America.

The Free-Market Faithful

Over the last decade, Latin American countries have divided themselves into two distinct camps:

  • Those that have economic challenges, but have embraced solutions that are more or less free market in nature.

  • And those that have abandoned or are in the process of abandoning the free market altogether.
On the one extreme, you have Chile, which built up a $19 billion stabilization fund as copper prices rose in 2006-08 - and then had cache of cash available to cushion the blow of recession in 2009.

That was under a center-left government; under the new center-right government of billionaire President Sebastian Piñera, which was elected in March, Chile's growth is accelerating. And its prospects under this well-respected regime appear excellent - even if commodities prices do not remain at current high levels.

Over the past few years, Colombia has joined Chile in the free-market group, and Peru is showing signs of doing so, depending on which candidate succeeds in the April 2011 presidential elections.

Canada is generally in this free-market group, too, with a state sector now smaller than the United States, though the Canadian government has a tendency to meddle in business decisions in a way that would not occur in Chile.

The Feckless, Anti-Free-Market Crowd

At the opposite extreme you have a number of countries, led by Hugo Chavez's Venezuela, which has abandoned the free-market philosophy and reverted to government control over the economy. After 12 years in power, Chavez's seizures of assets have become more blatant, while his attempts to involve international companies in developing Venezuela's Orinoco tar sands oil resources have so far produced more promises and up-front payments to the government than they have oil. Venezuela's economy has yet to recover from the 2009 recession, while its inflation rate is zooming past the 30% level.

Other countries following Venezuela's policy direction include Bolivia, Ecuador and Argentina. Fortunately for their feckless leaders, these countries have economies that are so heavily dependent on minerals, energy or (in Argentina's case) agriculture that with commodities prices at current high levels they can continue to grow - or at least continue to recover from the 2008-09 downturn.

In the long run, needless to say, countries such as Venezuela will find it increasingly difficult to coax even modest growth out of the economies they have burdened so badly.

Commitment Issues

The two biggest economies in Latin America - Brazil and Mexico - have failed to make a commitment either way, and therefore fall into neither group.

In Brazil's case, privatization and reform - mostly in the 1990s - have allowed the economy to enjoy a stunning boom in recent years. However, government spending soared out of control before the October 2010 election, while inflation is showing signs of taking off.

New Brazil President Dilma Rousseff appears to want greater state control and has shown signs of meddling with Brazil's major resource companies - Petroleo Brasileiro SA, better-known as Petrobras and Vale.

She has also removed the central bank chief, Henrique Meirelles, who had kept interest rates high and inflation under control. From where I'm sitting, it sure seems as if Brazil is heading at least partially in Venezuela's direction and current market optimism seems unwise.

Mexico is tougher to read. It has had a nominally pro-market government for the last 10 years, but few of the necessary changes (like privatizing the oil company Petroleos Mexicanos, or PEMEX) have occurred and growth has been sluggish. While growth has picked up in 2010 and is projected to be decent in 2011, the presidential election due in 2012 is a frightening prospect, with two of the three major parties likely to make things worse, instead of better.

Needless to say, the huge upsurge in drug-related violence in Mexico doesn't make me more optimistic, either.

The 2011 economic and investment prospects for markets in the Americas are tied critically to where commodities prices go. Given rapid growth in East Asia - and the very low interest rates worldwide - the odds of a continued increase in commodity prices in the New Year are strong, indeed.

Commodities prices will only stop rising when interest rates, particularly in the United States, are pushed up to levels that are well above inflation. That does not look likely in 2011.

Although inflation may be a problem in the United States by the latter part of the year, it's unlikely that the U.S. Federal Reserve will get around to doing much about it before 2012. So, on balance, we should expect a continuing escalation in commodity prices, although we should watch out for signals of a changing trend.

The New Year Outlook

Since the Americas region is the best place for investment in resource producers, that makes the outlook for 2011 very clear.

Look for attractive opportunities in Canada, Chile, Colombia and Peru, though maybe hold off on Peru until after the April election. Even here, don't chase valuations too far; these markets have already had a good run. You don't need to confine yourself to resource companies; those economies are so resource-based that they will enjoy rapid growth while prices are high, helping companies in all sectors.

In Canada, concentrate primarily on resource sectors. Outside resources, look for domestically-oriented companies. The country's manufacturing will benefit from the economy's growth but will find exporting difficult as the Canadian dollar will remain strong.

Lighten your positions in Brazil and Mexico, even in resources sectors. Prospects may be good for the next few months, but government meddling in Brazil and political risk in Mexico darkens the longer-term picture.

Avoid the "bad boys," even Argentina. Resources companies in those countries that make good profits will just make themselves attractive targets for government looting - so don't get tempted.

Overall, there are good investment opportunities in the Americas in 2011, but you need to tread carefully.
Action to Take: Look for attractive opportunities in Chile, Colombia, Canada and Peru. Let's consider each of these markets on an individual basis.

Chile: When you look at this Latin America economy, do so with the expectation that it is well-positioned to be an emerging-markets top performer in the New Year.

The most-straightforward way to travel is the exchange-traded fund route, via the iShares MSCI Chile Investable Market Index Fund.

In terms of individual stocks, I like Vina Concha y Toro SA, a producer of very-high-quality wine. It is currently trading at about 21 times earnings, with a dividend of nearly 4.0%. That's somewhat of a premium valuation, but I like the dividend and Vina Concha is unquestionably a premium company.

Colombia: There are only two Colombian shares with full American Depository Receipts (ADRs) on the New York Stock Exchange. Of the two, Ecopetrol SA is the more interesting. It's trading at 26 times earnings, and has run up 77% percent so far this year. But this oil-and-natural-gas player is participating fully in the expansion of the Colombian oil sector. According to a recent Barron's analysis, Colombia's total annual output is expected to average 800,000 barrels of crude and 1.1 billion cubic feet of gas daily, up 48% and 90%, respectively, from 2003. Why is that important? Because back in 2003, a terror campaign by leftist rebels was keeping wildcatters from drilling in Colombia's promising eastern provinces - a reality that induced the country's government to take a stand and fight for change. Those results show that the desired changes are taking hold.

In 2007, the Colombian government sold 10.1% of Ecopetrol to investors, a move that energized management toward becoming much more entrepreneurial in focus. Even with the run-up in stock price, Ecopetrol's shares still sport a 2.3% dividend yield.

Canada: It's not often that an investor can identify a specific market as "the world's safest economy." And, yet, because of Canada's remarkable mineral-and-energy resources and its superior banking system, that's precisely what we seem to have in this north-of-the-border nation. Not only that, but the most powerful long-term growth opportunities available to global investors today - commodities and natural resources - are on fire right now, which also plays right into Canada's hands. In short, Canada is clearly one of the top investment plays to make in the New Year.

Canada's most important strategic relationship with the United States is in the supply of energy, both from conventional oil and gas and from the Athabasca tar sands deposits in Alberta.

Of the Canadian oil plays, I most favor Suncor Energy Inc. because of its position as the most important producer of tar sands oil. This is only modestly profitable at lower oil prices. But if the "black gold" continues its advance, Suncor's tar-sands holdings can be expected to increase hugely in profitability. Another direct way to play the oil sands is through the Guggenheim Canadian Energy Income Fund, an exchange-traded fund (ETF) that focuses on the Canadian oil sands.

In Canada's very important minerals sector, I still like Teck Resources Ltd., which is a major producer of coal, copper and other metals. Teck's shares have run up about 48% from where I recommended them in September. However, Teck has the Chinese government's China Investment Corp. sovereign wealth fund as a strategic 17% shareholder (one of CIC's few really profitable deals, up more than 100% since it bought in close to the bottom of the market). Sovereign wealth funds don't buy into companies such as Teck on a lark - or seeking short-term profits. They buy in because they see major long-term potential.

As do I.

Although it will pay to concentrate primarily on resource sectors in Canada, look for other opportunities, too. Outside resources, look for domestically-oriented companies: The country's manufacturing will benefit from the economy's growth but will find exporting difficult as the Canadian dollar will remain strong.

Peru: With commodities prices trending upward, Peru should continue to do well: Its top four exports are copper, gold, zinc and crude oil, before you get to a group of agricultural products. The Economist team of forecasters predicts growth of just over 5% in 2010 and 2011, and that forecast may prove low if metals and energy prices continue strong.

On balance, attractive investment opportunities in Peru should be considered. But you might want to wait until after the April election.

There are a number of U.S. and Canadian mining companies with operations in Peru that should be reasonably safe from expropriation - even if metals prices continue to rise. That might bear additional investigation on the part of ambitious global investors.

There is also one interesting Peruvian-controlled miner listed on the New York Stock Exchange - Compania de Minas Buenaventura SA - that benefits from very favorable operating costs in its gold operations at below $300 per ounce. It trades at only 20 times trailing earnings, which isn't overly pricey - given the huge run-up we've seen in the market price of the "yellow metal."

This article is authored by Money Morning, a leading source of investment news research for the global markets.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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