Brazil is emerging as one of the great stories of the 21st
century. Sound economic policies and abundant natural resources
have led to sustained economic growth. And investors are racing to
get in to this Samba party -- the
iShares Brazil (
exchange-traded fund (
has risen nearly +20% since late August.
Thus far, Brazil's government has played its hand perfectly,
while stimulating growth. But the road ahead is bound to get much
trickier, and it's not at all clear that all the key metrics can
keep moving in the right direction.
The resource curse -- fueled by hot money
will be among the fastest-growing in the world in 2010. Foreign
capital flows are pouring in to capitalize on the nation's rising
economic prospects as well as the company's impressive position in
the global commodities sector. But Brazil is now feeling the
effects of what's known as the "natural resources curse" (also
known as the "paradox of plenty").
By exporting massive amounts of minerals, beef, oil and grains,
Brazil has been attracting a lot of foreign
. And as other resource rich countries such as Australia and Norway
will tell you, it's not long before the country's currency becomes
too strong -- so strong in fact, that it makes all other
export-oriented businesses much less competitive on the global
Policy makers in Brasilia are looking at the Brazilian Real with
dismay. The real has strengthened against the dollar for five
straight months -- making Sao Paolo and Rio de Janeiro the first
and third most expensive cities in the Americas, according to
Mercer Consulting. (New York is second.)
Part of the real's attraction is also due to relatively high
interest rates in Brazil. The government has kept interest rates
above 10% to ensure that inflation stays under control. So global
investors can sell currencies in countries where interest rates are
low and buy currencies, and bonds, in countries like Brazil (this
is known as the "carry trade"). If policy makers lower rates
to help beat back that carry trade, global investors will grow
alarmed that inflation may re-emerge while the economy is growing
at a very fast pace. And that would spell trouble for the BOVESPA,
Brazil's stock market.
has been buying back the real on foreign currency markets to help
weaken it, but that effort proved futile and was recently
abandoned. "It's very difficult for governments to do something
when a wall of money is coming in," said Mauro Leos, a senior
credit officer for Moody's, at a recent conference in Sao Paulo.
Not only has the Brazilian Real surged against the dollar, it's
also gaining steam on neighboring currencies. Argentina's peso has
declined nearly -35% against the real since May, 2009. That means
Argentinean businesses can start to steal business from their
Brazilian counterparts. Looked at another way, Brazilian
airplanes made by
are becoming increasingly expensive on world markets unless the
company chooses to slash prices, and profits, to stay competitive.
Currency traders think the real may power even higher. Currency
contracts in Brazil are anticipating a much greater likelihood that
the real will appreciate by at least +5% in the next six months
when compared to contracts anticipating that the real will weaken
by -5%. A net 250,000 contracts are going long on the Brazilian
Real, according to Bloomberg.
Action to Take -->
Brazil's strength in recent years has been derived from its
low-cost status and export strength. A rising currency changes the
whole game. Brazilian economic data will likely be strong in coming
months, and there's no reason to anticipate a swift market
reversal. But the odds are growing that the Brazilian economic
miracle will hit speed bumps. As investors flock to this market and
push it ever higher, the risks rise in tandem that a hangover and
correction will eventually hit. If you hold Brazilian stocks or
index funds, this may be a great time to take profits.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.