Still Betting on Brazil 

11/18/2009 1:00 pm EST

Focus: ETFS

Richard Young

Editor, Young's Intelligence Report

Richard C. Young, editor of Intelligence Report, says Brazil is an emerging economic power with a stable democracy and a healthy financial system.

As an investment destination, Brazil offers profound promise. Slightly smaller than the continental US, Brazil [has] a population of 190 million. More than half the population is now considered middle-class by Brazilian standards.

Unlike many emerging-market countries, Brazil is not overly dependent on commodities or exports. Its economy is highly diversified, with personal consumption expenditures accounting for 60% of [gross domestic product] and exports accounting for only 14.3% of GDP. Manufactured goods account for 60% of exports. Brazil is the world's seventh-largest manufacturer of automobiles and the fourth-largest manufacturer of airplanes.

Brazil is the only BRIC nation that is both a stable democracy and at peace with all its neighbors. Brazil's financial system is healthy: Total credit to GDP is only 41%. Brazil has $233 billion in foreign exchange reserves, which is equal to 19 months of imports and fully covers the country's public and private external debt.

Brazil is also endowed with natural resources. It is the world's leading exporter of iron ore, coffee, soy, orange juice, beef, chicken, sugar, and ethanol. Brazil has 958 million acres of highly productive arable land, with 222 million acres that have yet to be farmed. The country generates 73% of its energy needs from hydroelectric power. Brazil is also home to one of the ten largest oil reserves in the world, the Tupi field.

Decades of recurring turmoil, arcane lending laws, and high inflation have kept Brazil's economy underleveraged. Mortgage debt in Brazil is equal to only 2.5% of GDP, compared to 80% in the US. There is huge pent-up demand waiting to be unlocked in the housing sector. Mexico, which has 60% of the population of Brazil, builds four times as many homes.

Lower interest rates and changes to lending laws are likely to unlock Brazil's pent-up demand for housing over the coming decade. Falling interest rates have already begun to unlock credit growth in consumer loans—65% of car purchases are now made on credit, and purchases with credit cards have been growing at 22% annually during the past decade.

Brazil has always had great potential, but has consistently managed to stumble. Change is now under way. Inflation has been tamed, the state has found an acceptable balance with private industry, excessive government debt is no longer a problem, and stability has returned to the economy. A more stable Brazil should result in higher earnings multiples on Brazilian stocks, lower interest rates on Brazilian debt, and a more valuable currency.

You should continue to expect wicked volatility when investing in Brazil. The government still has its hands deep in the private economy, as evidenced most recently by the implementation of a tax on capital inflows. Plus, while Brazil is headed toward developed market status, it is not there yet. Begin with a starter position in Market Vectors Brazil Small-Cap (NYSEArca: BRF) or iShares MSCI Brazil (NYSEArca: EWZ), and add to your position on dips.

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