Author: Andy Djordjalian
Disclaimer: Andy owns SSRI, XRA and PBR in his Covestor South American Model.
September 7, 2010: The South America model at Covestor returned positive results in August even though the S&P 500 finished in the red, as well as Latin America as indicated by the iShares Latin America 40 Index ETF (ILF). It was a mediocre month for Brazilian stocks – the largest Brazilian fund, iShares MSCI Brazil Index (EWZ), fell from $ 70.38 on July 30 to $67.75 on August 31 – but the Chilean and Peruvian equity in my portfolio performed well. Nevertheless, the main contributors for this model were two of the three Canadian miners with operations in South America that I hold, Silver Standard Resources (SSRI) and Exeter Resource (XRA), which responded to strengthening gold, silver and copper prices.
Besides the rising prices of metals, another explanation for the good performance of Silver Standard could be their report on the Snowfield-Brucejack gold project, where recent exploration has extended the known mineralization of what could become one of the largest mining complexes in the world. Exeter has a Resource Estimate Update for their Caspiche project scheduled for this month. I would not be surprised if these two stocks experience some interesting movement during September too.
Speaking of news to expect, two significant events are taking place in Brazil this month: the final track of the presidential campaign and a huge stock offering from heavyweight Petrobrás (PBR) for financing development at the oil-rich pre-salt fields.
The presidential elections in Brazil will take place on October 3. The ruling party’s candidate, Dilma Rousseff, is leading the polls fairly comfortably. Neither she nor her best-positioned opponent, José Serra, are expected to deviate from the current market-friendly policies of President Lula da Silva. However, some analysts are demanding more definitions on their views and strategies for the Brazilian economy.
I would not expect a great amount of detail from Rousseff (or Dilma, as many Brazilians prefer to call her) because, to my understanding, in politics, candidates that are winning by sufficient margin avoid creating waves, as they would if they offered details that may conflict with certain interests. They have more to lose than to win. Especially in democracies in Latin America, which are not yet mature as in the U.S. and Western Europe.
For example, it was reported that Dilma’s team would be preparing budget cuts, but she denied it repeatedly since. The Wall Street Journal quoted her saying “I’m not going to carry out a fiscal adjustment under any circumstances,” and little more than that (http://online.wsj.com/article/BT-CO-20100830-711660.html, August 30, 2010). But we can hardly understand her views if we read just one or two phrases out of their context. A complete interview with Globo held on that same day (in Portuguese) paints a richer picture of her ideas (http://g1.globo.com/jornal-da-globo/noticia/2010/08/jornal-da-globo-entrevista-candidata-dilma-rousseff.html, August 30, 2010).
Rousseff explains to Globo that she associates the phrase “fiscal adjustment” with expenditure cuts plus tax hikes as were required by Brazil in the past, when inflation was a menace, international reserves were at much lower levels and the debt-to-GDP ratio was rising. What she defends for the present is what she calls “expenditure control”, meaning to spend an adequate quantity and only for quality projects. The use of this euphemism, or “marginal adjustment” in another interview, might be to avoid disturbing the left wing of her party. What she pledges is to maintain the steady reduction of the debt-to-GDP ratio as the country grows, the improvement of the rate of investment (now at an unimpressive 19%) and the convergence of the currently-high interest rates to international levels.
When asked about how to improve the worsening balance of payments if budget cuts are not implemented right away, she answered that those disbalances were caused by Brazil recovering from the crisis more quickly than developed economies, which are not yet demanding many Brazilian products while Brazilians do buy much from them. She said that these problems will be solved when the world economies recover.
She does have a point, I mean, Brazil cannot be analyzed in isolation. A deficit in the current account is probably their share of today’s global troubles, and so is the arguably-high value of their currency, the real (pronounced ray-al but with a very weak ‘y’ and a starting ‘r’ that sounds like mixed with an ‘h’, as in French), as interest rates in reals are high compared to other currencies’ because they are keeping inflation in check while the other countries are more concerned about deflation right now. This has an effect on the value of their currency, because those higher interest rates create a demand for more reals. This kind of phenomenon is called (currency) carry trade, a term that is frequently mentioned in this time of generalized economic disbalances.
Of course, if the price of iron, coffee and soybeans weakened severely, the deficit in the current account would be a bigger concern, as it would if the global economy happened to dip again, which I do not consider a probable outcome but it is a possible one. Nevertheless, if those risks did not exist, Brazilian equity would be more than a bargain – they would be an absolute steal at the current prices.
In other interviews Rousseff spoke about cutting red tape and improving the ease of doing business in the country, which is an area with room for improvement. Overall, I am satisfied with her discourse. I do not discard the possibility of seeing high spending in infrastructure centralized too much in government, but Brazil has good uses for those initiatives. On the other hand, I think she is showing soundness and “market consciousness”. I do not expect a stronger emphasis in that direction before the elections, given her position in the polls and the internal politics of her party.
I intend to maintain my portfolio fully invested and well diversified among these and other South American opportunities. Thank you for your interest, I wish you a pleasant and fruitful September.
