New wealth from commodities is fueling growth and expanding the consumer economy. And that presents great opportunities for investors
by David Bogoslaw
The Brazilian economy is barely recognizable to those who knew it more than five years ago. In those days it was plagued by mountains of debt and boom-and-bust cycles. Now everything is different. Indeed, 2008 is quickly shaping up to be the Year of Brazil.
The economy is ready to burst at the seams—but this time the growth looks sustainable. And foreign investors are taking notice in a big way. Should you join them?
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Company/Fund Ticker Return YTD
Petrobras PBR +14.8%
Companhia Vale do Rio RIO +17.8%
BlackRock Latin America MDLTX +14.45%
DWS Latin America Equity SLAFX +12.63
Fidelity Latin America Fund FLATX +12.58
First, it's worth looking at some telling figures. Brazil's gross domestic product increased 4.5%, to $1.3 trillion, in 2007, and grew by 5.8% in the first quarter of 2008. The country's benchmark stock index, the Bovespa, is up 5.9% thus far in 2008.
Brazil is on the right side of the global commodities boom. It has enjoyed a 65% price hike for the high-grade iron ore it sells to steelmakers around the world. In the midst of a staggering increase in world energy prices, Brazil stands ready to capitalize on newly discovered offshore oil deposits that may be part of one of the biggest oil fields in the world. Major credit-rating agencies have given their stamp of approval on its government debt by upgrading the country's sovereign rating from junk.
What makes the story even more compelling is how Latin America's biggest economy has largely kept a lid on inflation, even as central banks around the globe continue to battle it. The reason: Brazil's self-sufficiency in many of the commodities whose price run-ups are causing consumer prices to soar worldwide.
Not Playing Politics
Still, there has been concern about consumer prices, which climbed more than expected to an annualized rate of 5.04% in April, prompting the central bank on June 4 to raise interest rates to 12.25% from 11.75%.
"Brazil's central bank has gained a lot of credibility by not allowing politics to interfere with the rate cycle. It's one of the few central banks that's ahead of the game and not playing catch-up," says Will Landers, who manages the $970 million BlackRock Latin America Fund (MDLTX) and the $1.5 billion BlackRock Global Emerging Markets Fund (MDDCX).
Continued strength in Brazil's currency, the real, "demonstrates the market's confidence that the government is on top of inflation," says Julian Thompson, portfolio manager of the $730 million Threadneedle Emerging Markets Fund (IDEAX) in London, roughly 21% of which is invested in Brazil.
None of this will come as much of a surprise to money managers or investors who have been looking for opportunities to diversify their portfolios away from assets based in the world's industrially advanced countries. The giant emerging markets Brazil, Russia, India, and China (BRIC) have gained popularity as investors watch their economies expand at a sometimes dizzying pace.
But not all BRICs are created equal. With oil and metals price going through the roof in the past year, savvy investors are starting to distinguish the growth prospects of commodity-producing countries like Brazil and Russia from those of Asian countries that have no choice but to pay up for these resources to build their electricity grids, roads, bridges, and overall manufacturing capabilities.
The Glow from Petrobras
At the lead of Brazil's economic boom is Petrobras (PBR), the state-owned energy giant whose oil production is projected to grow 12% this year and 10% in 2009, says Thompson. Petrobras stock has jumped 16.4% thus far in 2008 on a stock-split-adjusted basis.
The potential from exploration in the oil reservoir off the coast of Rio de Janeiro suggests high production growth for Petrobras in the next 10 years, he says. Reserve estimates for the Tupi oil field range from 5 million barrels to 30 billion barrels—even Petrobras admits it doesn't know how big it is—and production isn't expected to come online for another four to five years.
Brazil has seen the need to become self-sufficient in oil since struggling with a hefty trade deficit amid hyper-inflation in the 1990s. "When Brazil had balance-of-payments problems, Petrobras continued to invest in exploration, even when oil prices were low," he says. "There was a strategic imperative to reduce the dependence on foreign oil, while other countries had less pressure" to do so.
Brazil has other high-demand commodities up its sleeve, too. The global steel market shows no signs of slowing, as long as developing countries continue to expand their infrastructure. Future price hikes by iron ore producer Companhia Vale do Rio Doce (RIO) are underpinned by strong demand in China and India and the difficulty of bringing on new supply to meet demand, says Thompson. "Iron ore looks like an extremely attractive commodity for us over the next five years at least," he says.
Ferrying Ore to China
And to get a bigger chunk of China's market, CVRD is building a small fleet of mega-freighters able to carry a lot more iron ore to China, serving the small customers that until now haven't been able to afford to sign long-term contracts with the company, says Landers at BlackRock. The company is targeting a 50% boost in sales to China starting next year.
Even so, CVRD is trying to diversify its business, adding nickel production by acquiring Canada's Inco two years ago, and planning to expand into copper and other materials as well.
But Brazil is turning out to be much more than simply a bet on continuing spikes in commodities prices. A strengthening consumer sector—willing to take on debt to finance purchases of an array of goods—is also catching the eye of money managers.
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