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Guild’s Premium Global Market Commentary

Guild’s Premium Global Market Commentary

Beyond Beasts and Bossa Nova: The Brazilian Boom

For many people, the word Brazil conjures contrasting images of endless Amazonian jungles, jumbo snakes, man-eating piranhas, the dazzling beaches of Rio, and of Carnival, the world’s biggest party.

Olympic and World Cup fans are looking forward to visiting Rio de Janeiro

Source: American Travel Club

Today, you have to add the word ‘boom” to the Brazilian national resume.  It’s ten years old and going strong, driven by rising production of everything from autos and computers to farm products and minerals. The country’s growth has, in turn, been pushed by huge waves of exports to Asia, Europe, and North America, along with big-time domestic consumption of housing and consumer goods.

The boom has created a much larger middle class than existed ten years ago and transformed Brazil into more than just a fast-growth economic player on the global stage.  It has also turned many Brazilians into a jet set army of shoppers who flock to Fifth Avenue and Florida for big savings. Believe it or not, Brazilians, as a national group, are the leading foreign shoppers in New York City.  In 2010, they spent more money in the Big Apple than natives of any other country, ahead of Canada, the U.K., and Italy.  In the state of Florida, Brazilians are second only to snowbirding Canadians.

There are a couple of good reasons why Brazilians like to shop in the U.S.:  1) Avoid paying a high value-added consumption tax, and 2) the Brazilian currency has risen by 25 percent versus the U.S. dollar since 2009.  Together, these factors make Brazilian products very expensive at home and make shopping in the U.S. well worth the airline ticket and hotel bill. An Apple iPad, for instance, will cost half the price in New York as in Brazil. Some specialty products may be only a quarter the cost in the U.S. that they sell for back home.

The Guild Guide to Brazilian Investments

What does all this mean for those who wish to invest in Brazil? It means that when it is time to buy Brazil – and the time isn’t here yet – you will want to consider banks and credit card companies as a way to capture the wave of consumer cash since many consumers go abroad to buy personal and pricey consumer goods. To take advantage of rising internal Brazilian spending you will probably want to consider autos, housing, and big ticket durables that will not fit into the luggage of shoppers returning from spending trips abroad.

That’s the general picture.  However, investing in any market sector in Brazil, or for that matter in any country, requires a great deal more than just top-down thematic insight. We like the prospects of Brazilian banks and credit card issuers, homebuilders, auto and appliance manufacturers, and the makers of steel from which many of these products are constructed.  They are all beneficiaries of Brazil’s growing and spending middle class.  Sugar producers in Brazil may also be beneficiaries of another trend which we will discuss in next week’s Premium Global Market Commentary. However, a top-down approach can only point out potential countries and industries as investment targets. To go further, and fully analyze companies, there are many other variables to consider – and such consideration and study in Brazil and elsewhere is a primary preoccupation at Guild Investment Management.

As an example of what’s needed to make an informed investment in a particular sector, we chose homebuilding.  With homebuilding one needs to understand many factors. They include tax policy, interest rates (present and expected) as compared to the inflation rate (present and expected), the operating skill of management, the price points of homes to be built, financing availability, affordability, and a knowledge of the markets that builders are addressing. In addition, there is the issue of relative P/E ratios versus growth rates; the economic, political, and investment backdrop of emerging markets in general; and Brazil in particular.

Brazil’s Bovespa Index- Last 10 years

Source: Bloomberg

 

The following lineup represents sectors we are keeping our eyes on for the time when Brazil does become attractive.

Homebuilding – Brazilian homebuilder stocks experienced a rough 2011 due to rising interest rates in the first half of the year. They sell at trough valuations. The largest publicly- traded residential constructions companies are MRV Engenharia (Bovespa: MRVE3); Gafisa (NYSE: GFA, Bovespa: GFSA3); PDG (Bovespa: PDGR3); and Cyrela Brazil Realty (Bovespa: CYRE3).

Banking – The six largest Brazilian banks account for more than 75 percent of bank lending and credit issuance in Brazil. Only four are publicly traded. They are Banco Bradesco (NYSE: BBD, Sao Paolo: BBDC4); Itau Unibanco (NYSE: ITUB, Sao Paolo: ITUB4), Banco Santander (NYSE: BSBR); and Banco do Brasil (Sao Paolo: BBAS3). The country’s smaller banks have much higher funding costs because they do not have access to international markets.  They require government assistance to compete. They are less attractive in our opinion.

Automobiles and Motorcycles – Brazil ranks fifth in automobile production worldwide (about 3.5 million units made in 2010). The country cranks out cars – and motorcycles as well – for large global multinationals like Ford, General Motors, Toyota, Fiat, Honda, and Yamaha.  Although auto sales are robust, there are few pure plays in this sector.  We are investigating ways to take advantage of this opportunity when the Brazilian market gets attractive.

Steel – Autos are made partly of steel and are just one factor in the growing attraction of Brazilian steelmakers. We will discuss this sector in detail in a coming issue and make a specific recommendation as soon as the opportunity ripens.

Brazil – In Summary

Many Brazilian stocks suffered major declines in 2011 and the time for investing has not arrived yet.  Our review is a heads-up.  From our standpoint, even when markets are not attractive, working on a potential buy list can be a valuable exercise.  As we recognize openings ahead, we will recommend specific groups to you and give more in-depth reasons why we like them. We continue to monitor the scene and do our homework so that we will have a good selection of recommendations to make at the right time. For now, you may want to add these ideas to your watch list for the buying opportunity to come.

China 2012: Looking Good

China, according to a December 14 report from Reuters news agency, has pledged a growth guarantee for 2012 despite a poor outlook for global economics. Here are the key snippets from the report:

  • China is “laying out a blueprint for the world’s second largest economy in the year ahead.”
  • Beijing promised to keep monetary policy “prudent,” fiscal policy “proactive,” and consumer prices “stable.”

The language is broadly in line with previous commitments. To us, this means that China’s GDP will grow at a rate below 9 percent for three to six months in early 2012 and then accelerate.  The speed-up will occur because of the continued cuts in the reserve requirements by banks that will allow capital to flow more freely into the economy.

The Chinese Copper Caper: A Lesson in Market Manipulation

You probably haven’t noticed but Chinese refined copper imports have hit a 2 1/3-year high as copper prices have fallen to lower levels. Give credit where credit is due.  The Chinese have artfully played the system. They made huge purchases without driving prices up.  Just the opposite, in fact! China clearly plans to use plenty of copper over the next year or two and will have a large stockpile, smartly bought, with which to do so.

A closer look at this development further reveals China as a master market manipulator. You may remember that we have pointed out many times in past years that the Chinese may often say, “oh, we will not need any nickel (or any industrial metal) this next year, and we will be selling to diminish our stockpiles.”

Due to non-Chinese speculators, excessive leverage of their portfolios and the fear factor, world prices then subsequently drop. The Chinese then move from small seller to big buyer; going into the market to scoop up future supplies at low prices. In the instability that ensues, the wily Chinese may then sell off a tad to keep the markets guessing.  They will also go out and buy discreetly through intermediaries, buying more than they are selling publicly, thus locking in their stockpiles at lower prices.

The Chinese are smart. They view things with a long-term perspective.

The lesson for you is to be cautious when the Chinese say they are selling an industrial metal or energy material.  They may just be taking advantage of the system.

China’s Baubles

A final Chinese observation to share – Retail sales have boomed in 2011 because many more Chinese are rushing to purchase consumer goods. Now that home prices have begun to fall or stabilize, the public is spending more instead of saving for an immediate down payment on a home. The strongest retail segment has been gold, silver, and jewelry, a result of expanding retail store infrastructure throughout the country, especially in the smaller cities where wealth is growing rapidly and, secondly, where an attitude of consumerism is eclipsing saving. Consumers who want to show off are doing so with gold, silver, and jewelry.

The Canadian Wheat Scramble

On December 16, the Canadian government ended its 70-year monopoly of the domestic wheat trade. Previously, farmers could only sell to the Canadian Wheat Board. Now, they can sell on the market as do U.S. farmers. Many farmers have already hailed the action. It gives them a better chance to profit from the rising price of wheat that will occur as the U.S. dollar declines. As readers know, wheat is priced in U.S. dollars on a global scale.

Here are some background wheat facts that you should know:

  • Wheat contains more protein per bushel than corn (maize).
  • Wheat is the number one source of vegetable protein for humans.
  • Corn is the most widely-grown grain and much of it goes for animal feed.

Harvesting profit on the prairie

Wheat has fallen in price versus corn to the point where wheat now provides a better value for animal feed. We expect this to create new markets for wheat. Wheat growers and grain handlers will want to hedge their crops and more farmers will want to grow the grain. We foresee more profits for grain handlers, less government bureaucracy involved, and more demand for futures exchanges to hedge crops. We think that many farmers in Canada who had given up wheat (not liking the politicized government system) will now return to the fold. Over the long run we expect a greater Canadian supply, a bigger demand, and bigger profits for wheat farmers. We also expect a much bigger hedging program by Canadian wheat producers. Commodity exchanges are already competing for this business.

In the U.S., we expect some substitution of wheat for corn because of the politicized and inefficient system where the latter is used for ethanol, artificially increasing its price and decreasing the supply available for feed. The artificial corn shortage created by ethanol demand will create demand for the higher-protein wheat.  Combine this situation with the recent news from Canada and you have further reason for liking wheat.

Wheat Price (CBOT) since 1990

Souce: Bloomberg

Here’s yet another reason: current poor growing conditions in South America have damaged the corn crop.  Rains have been less than expected and forecasts for dry weather ahead have caused grain futures in the U.S. and Europe to rise. The magnitude of wheat price rises in the near term will be affected also by South American corn production shortfalls as corn users may substitute wheat.

How To Play Wheat?

Investors can buy wheat futures in the U.S. and several other countries or wheat exchange traded funds that trade in the U.S. and the U.K.

In our Global Market Commentary, Guild Investment Management, Inc. currently has a long-term buy recommendation on wheat which was placed on October 24th, and it has risen by 3 percent since our recommendation.  We first recommended buying wheat on December 31, 2008, and then recommended taking profits in March of this year after it had risen about 35 percent.  We track our recommendation based on the price of cash wheat as designated by the Chicago Board of Trade’s rolling futures contract.

Meanwhile, Europe is Still Sick and Not Out of the Woods Yet

The vital signs of Europe’s chronically ill financial house are better, but is the big bad wolf still lurking in the bushes?

Last week, some 500 banks borrowed about 490 billion Euros (some $637 billion U.S. dollars) in the form of three-year loans from the European Central Bank (ECB).  The stronger-than-expected demand for ECB cash came shortly before several months of very large refunding activity will take place in many Eurozone countries.

The question at hand is whether banks will use their money to continue buying the toxic debt at high yields of the weak European peripheral countries, like Spain and Greece, or have they learned their lesson?  In June 2009, European banks received over a half-trillion dollars in government loans. About half of the money was spent on peripheral nation sovereign debt, which has been the source of much of Europe’s ongoing financial woes. Hopefully, they use the cash this time to shore up their balance sheets and avoid buying bad bonds.

 

The Next Big QE  or other bailout for Europe = Opportunity

Currently, we are working on a buy list and preparing to take advantage of global market opportunities. We expect multiple opportunities ahead when a concerted quantitative easing “jamboree” or a more subtle type of bailout of European banks occurs with the U.S., Europe, Britain, Switzerland, Canada, and Japan taking part.  Quantitative easing, or QE for short, means extraordinary money creation. We may see QE or we may see a more creative type of bailout using other tools from the central banker’s tool box.  For example, today we are aware of swap lines from the U.S. to Europe and Japan which are being used to provide liquidity to financial institutions in Europe and possibly Japan. The purpose of these swap lines is provide liquidity when normal liquidity sources dry up.  Until recently European banks were funding their activities using money from U.S. money market funds and through bank loans from US banks. When the funds and banks became afraid of the risk in European banks they withdrew their loans and now the U.S. Fed has stepped into provide the liquidity that has been removed.  The use of swap lines to accomplish this is not a typical approach and as such has escaped notice until now. Hints of this type of program have begun with the U.S. Federal Reserve surreptitiously engaging in swap transactions with the European Central Bank (ECB).  Stay tuned.  We will write much more on this next week.

Here’s a preliminary look at how we see the opportunities shaping up.  We will recommend taking action when the major QE program or another type of bailout is implemented. In the meantime, here are some general parameters.

  • Continue avoiding European banks and most European stocks that are not more than 50 percent export-oriented to non-European destinations. Asia would be the preferred export customer.
  • Own gold as an insurance policy. We are not concerned if it rises in the short term. Gold can help hedge European meltdown risk and benefits from continued currency debasement.
  • Be prepared to buy growth stocks in Europe, the U.S., and in Asia only when the investing public becomes aware that QE or other bailout program has been activated. It has already been activated in our opinion, but investors who are mostly traders and not economists have not yet realized what is going on. When they do come to that realization we expect a big rally that will be must like the rally that occurred in 2009 and early 2010 after the bailout of U.S. banks and insurance companies.  Stay tuned…
  • Consider becoming a Gold Subscriber to receive the Guild Global Market Commentary Premium so that you will be able to track our new recommendations.  Current subscribers to the free Guild Global Market Commentary will be notified if any changes take place in the 4 outstanding recommendations that we have on gold, wheat, and the Singapore and Canadian dollars.
  • You will be receiving an email at the beginning of the New Year with instructions on how to become a Gold Subscriber to the Guild Global Market Commentary Premium Edition.

We would not buy Europe yet; we own gold, and recommended taking profits on U.S. stocks this week.

Why are we not currently in the buying mood? Unfolding events could drive stocks further down before they go much higher after the big quantitative easing ahead.  We will continue to hold gold while we wait.

Recommendations Summary

Beginning in 2012 our new recommendations will be included in the Premium edition of the Guild Global Market Commentary, which will be made available to our investment management clients for no charge and to our paying Gold Subscribers.

Please click here to view our recommendations.