by Ivan Martchev | June 7, 2010 11:00 am
BRIC investments and Brazil funds have huge potential right now, and Brazil is my favorite natural resource market. Unlike BRIC market Russia, It has no Putin effect and a very conservative central bank, which in today’s world of printing money is beginning to sound like an oxymoron. Brazil Investments, BRIC Funds & BRIC Investments[1] can be incredibly profitable for investors. The key to investing in Brazil is understanding that the headline index is dominated by a couple of big companies — Petrobras (NYSE: PBR[2]) or more formally Petroleo Brasileiro, and Vale (NYSE: VALE[3]).
You have to have an outlook on both if you plan to buy the Brazilian iShare (NYSE: EWZ[4]) as they comprise nearly 40% of that ETF — this ETF is a de facto play on deep-sea oil, which requires complicated financing, and metal prices, which are a direct China play.
Petrobras is raising $25 billion to develop deep-sea oil with better technologies than those that failed British Petroleum (NYSE: BP[5]). The stock has been a drag on the Brazilian market with its huge market cap of $161 billion. Due to the uncertainty and size of the secondary offering — until yesterday that is — the stock drifted lower for the past six months, despite a rallying energy sector worldwide.
The fact that the share sale is proceeding is a sign that there is investor interest and that the recent selloff in Brazilian stocks was only a correction. The company needs to spend $220 billion in the next five years — the largest such spending program in the world. The Chinese are also making loans for these deep-sea oil projects. Any slowdown in drilling based in the BP accident is bullish for oil prices long-term because based on current consumption patterns, oil in 10 years will cost a lot more than the $150 all-time high reached in 2008.
Vale is the world’s biggest exporter of iron ore and China is the biggest buyer of the commodity. While China’s economy is about $5 trillion in size (about a third of the U.S. or the E.U.), China ends up as the biggest buyer for many commodities because it is building out its infrastructure. Emerging markets natural resource growth is more natural resource-intensive by a factor of two to three when compared to growth in developed markets. Given that emerging markets growth is much faster, you have a rapidly-rising demand for natural resources.
Both the Chinese and the Brazilian central banks are in tightening mode, so it is normal for Vale to spend some time digesting the huge gains from 2009. But there is no doubt that given the dominant position in key metal markets, any weakness in Vale’s stock should be used for investors to build positions. You have one such opportunity at present.
Small-Caps Have a Different Angle
The Market Vectors Brazil Small-Cap ETF (NYSE: BRF[6]) is a play on domestic demand themes like homebuilding and consumer goods. Think of the Brazil Small-cap ETF as a play on the real Brazil, as none of the components has an ADR. Also, the BRF constituents have to be domiciled or listed in Brazil and they have to have at least 50% of revenues generated in the country; this is not the case with large multinationals like Vale and Petrobras that are leveraged more towards international metals and energy markets.
These are very small companies — the largest has a market cap of just $38 million. I wonder how trading in the ADR with volumes that now vary between 500K and 1 million shares per day affects those stocks in the local market.
| Top 10 BRF Holdings | Market Value | % of net assets |
| Lojas Renner SA LREN3 BZ | $38.0 million | 6.14% |
| Sul America SA SULA11 BZ | $31.4 million | 5.06% |
| Gafisa SA GFSA3 BZ | $23.9 million | 3.85% |
| CETIP SA – Balcao Organizado de Ativos e Derivativos CTIP3 BZ | $23.9 million | 3.85% |
| BR Malls Participacoes SA BRML3 BZ | $23.5 million | 3.79% |
| Diagnosticos da America SA DASA3 BZ | $23.5 million | 3.79% |
| Anhanguera Educacional Participacoes SA AEDU11 BZ | $22.4 million | 3.61% |
| Totvs SA TOTS3 BZ | $19.4 million | 3.13% |
| Transmissora Alianca de Energia Eletrica SA TRNA11 BZ | $17.1 million | 2.75% |
| Multiplan Empreendimentos Imobiliarios SA MULT3 BZ | $15.4 million | 2.49% |
Think of the BRF as similar to the Morgan Stanley China A-Share Fund (NYSE: CAF[7]), which offers you the sole opportunity in the U.S. to buy A-Shares that also have no ADRs. But, in this case it is an even better investment vehicle as you do not have big deviations away from net asset value as you have with closed-end funds. As a reminder, ETFs like the BRF have active arbitrage between the underlying securities and the ETF price itself, where closed-end funds like the CAF have no such arbitrage available. This is why closed-end funds can trade at substantial premiums or discounts to the value of the securities that are in the portfolio.
I like both the EWZ and BRF for as they give you exposure to different parts of the Brazilian economy.
From a trading perspective, the rally that started a week ago still has legs and the small-cap ETF should outperform to the upside. From a more strategic longer-term investment perspective, observe the chart above how the Bovespa benchmark index has trounced the S&P 500 over the past decade. Why the majority of U.S.-based investors are still allocating money to the S&P 500 is beyond my comprehension at this point. You tripled your money in Brazil investments[8] while you lost money in the U.S.
The only secular growth stories remain in emerging markets and natural resources.
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