Latin America

Collapsing Colombia could spell opportunity

If you say the word “Colombia” to a non-Colombian the chances are they will think of three things: coffee, cocaine and conflict. Like most stereotypes and generalisations there are elements of truth to be drawn from them, but they are also deeply misleading. As investors on the search for opportunities we need to take a much closer look at the real situation. There’s a lot more to Colombia than these “three Cs”, and a sharp fall in the stock market presents us with a very interesting buying opportunity.

 

Yes, Colombia produces some of the best coffee in the world (the best according to my Colombian colleague at OfWealth, but then he would say that). Yet agriculture is less than 7% of the economy, which is dominated by industry and services. For example, Colombia boasts the world’s largest opencast coal mine, called El Cerrejon.  (Note: this article was written shortly after a trip to Colombia.)

And yes, Colombia did produce vast amounts of cocaine for the international markets, and the business was run by mega rich and violent drug gangs. The most famous drug baron of them all, Pablo Escobar, was estimated to be worth US$30 billion until he was tracked down and killed by police in 1993.

Plus the government fought with left wing guerrillas and right wing paramilitaries for decades. Because of these groups and the drug gangs, travelling around much of Colombia by land was a risky business. People would fly between cities because the risk of kidnap on the open highway was too great. The 1980s and 1990s were particularly violent.

But nowadays the country is largely peaceful. Drug production is down dramatically and the gangs no longer have the money or power they once enjoyed. And a peace settlement, launched in 2012 but still under negotiation in Cuba, has largely been agreed between the government and the FARC, perhaps the most famous of the revolutionary groups.

This new era of relative peace has allowed Colombia to prosper. In the past decade annual GDP growth has typically been in the 4% to 6% range. That may not be as impressive as China, but it’s certainly way ahead of the typical 2-3% rates of growth in developed countries (when they’re not doing even worse).

Colombia has decent public finances too. Government debt was just under 32% of GDP at the end of last year, having fallen from 36% in 2011.

Colombia has decent public finances too. Government debt was just under 32% of GDP at the end of last year, having fallen from 36% in 2011. That means the government has been living within its means in recent times – a rare and admirable thing these days. And it’s a far cry from the debts of developed countries, which are mostly well above 100% of GDP.

Inflation has taken off a little recently, from less than 3% during 2014 to just over 4% year-on-year in February. But again this is a far cry from the high rates in some other countries, and certainly nothing to panic about.

My overall impression – seeing the construction and consumption going on all around – was that Colombia is a thriving middle-income country. According to the IMF it had GDP per capita of US$12,776 in 2013 at purchasing power parity, or PPP. (PPP just means adjusted for the local cost of living, which makes it easier to compare countries on a like for like basis.)

That puts it around the same level as Thailand (US$14,136), South Africa (US$12,507) and China (US$11,868). So Colombia still has a long way to go to realise its full potential, but appears to be on the right track.

As I mentioned before, a few years ago many analysts were tipping Colombia as a great investment destination. But I had my doubts. It wasn’t that I didn’t agree with the arguments for Colombia to grow. It was simply that it never looked like much of a bargain. With stock market P/E ratios typically in the high teens it just didn’t seem to be great value. There were better things on offer around the world.

But things change over time. If you’re patient then you will be rewarded with much lower prices…eventually. This has now happened in Colombia.

…the local currency, the Colombian peso, has fallen hard against the US dollar, with the stock market taking an even bigger nose dive.

Specifically the local currency, the Colombian peso, has fallen hard against the US dollar, with the stock market taking an even bigger nose dive. The reason? Well, it’s largely to do with the collapsing price of oil. Brent crude oil, the main international benchmark, is down 53% since June 2014.

The problem is that the government relies on around half of its tax revenues from the oil industry. So the collapsing oil price has resulted in massive selling pressure on the currency, as also witnessed with the Brazilian real and the Russian rouble over the past year.

This in turn has encouraged many investors to pull their money out of the Colombian stock market. (As an aside, it’s interesting to note that over the past year the Chilean peso has actually been stronger than the euro against the US dollar.)

Let’s look at the numbers. The MSCI Colombia index – which is measured in US dollars – peaked at 1,388 on 5th February 2013. Over the next year it fell all the way to 894 before rebounding to 1,170 by 2nd September 2014, down 16% from the 2013 high. Over the same period the Colombian peso fell just around 6% against the US dollar (from 1,784 pesos per dollar to 1,895 pesos per dollar).

But then the real weakness kicked in. The peso began to fall hard and at time of writing it’s at 2,625 per US dollar. That’s a fall of 32% since February 2013.

Taking its cue from the currency, the stock market collapsed as well, especially in dollar terms. The MSCI Colombia index has fallen to 615, which is a full 56% below the February 2013 high. That’s a big fall by anyone’s standards. The following chart shows the index over the past three years (source: MSCI).

MSCI Colombia index US dollars

colombiamsci

You can see that market still appears to be in freefall to this day. So although Colombian shares have become much cheaper it’s probably still too early to pile in.

But this is definitely a market to watch. Not least because country stock markets that suffer big falls driven by currency weakness have a big tendency to rebound in a big way shortly afterwards.

…when currencies collapse the country’s government usually takes steps to stabilise the situation.

This is most likely because when currencies collapse the country’s government usually takes steps to stabilise the situation. Once the dust has settled investors realise that the stock market sell off was overdone and prices are driven right back up again. This can happen even without the currency having to recover much ground – it just needs to stabilise.

Of course there’s no guarantee that this will happen in the case of Colombia, but I can give you two recent examples of where it has. India and Russia.

The MSCI India index fell 46% between 9th November 2010 and 28th August 2013 as the Indian rupee fell 31% against the US dollar, largely during 2013. Since that low Indian stocks are up 67% in US dollar terms, accompanied by a 20% bounce in the currency.

Indian roller coaster (MSCI India index since November 2010, US dollars):

indiamsci2014

Another example, although it’s still early days, is Russia. The MSCI Russia index fell 70% between 8th April 2011 and 16th December 2014 as the currency fell 56%, largely during 2014. Since the December low the currency has regained 4% but the stock index is up 32% in dollar terms. That’s a big leap in just three months.

Both the Indian and Russian examples illustrate stock markets that became heavily oversold at the same time as those countries’ currencies were collapsing, albeit for different reasons.

But it looks like we still need to wait for Colombian markets to stabilise before piling in. As they say, there’s no point in trying to catch a falling knife. But it’s definitely one for the watch list.

One easy way to invest in Colombian shares is via the Global X MSCI Colombia ETF (NYSE:GXG). It’s invested in 26 companies with average market capitalisation (value at current prices) of US$5.3 billion per company.

GXG’s P/E ratio is 11.6 using last year earnings, the price-to-book ratio (P/B) is 0.75 (which means it’s trading below liquidation value of 1 – a sure sign of a bargain), and the dividend yield is a relatively high 4%. Those are already pretty attractive numbers but caution is required. Prices could well be headed lower still.

It looks like the collapse of Colombia’s stock market isn’t over just yet. But it’s definitely a place to keep an eye on, fellow OfWealthers. Market collapses of this nature often offer us the best opportunities to invest.

And if that doesn’t take your fancy, then perhaps a holiday in Colombia will. After all, it’s a lot cheaper than it was.

Stay tuned OfWealthers,

Rob Marstrand
robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.