Latin America

The best place to invest in South America?

A question for you: what’s long and thin and full of copper? Most people would probably answer an electric cable. But there’s something else.

In fact it’s not a thing at all, but a country. I’m talking about Chile, a country that is 4,270 kilometres (2,653 miles) from north to south, but averages only 177 kilometres (110 miles) distance from east to west.

Map of Chile
Map of Chile

Chile is wedged between the Andes mountain range and the Pacific ocean, in the South West of South America. It shares most of its border with Argentina to the east, Bolivia in the north east, and Peru in the north.

Chile’s main contribution to the global economy is that it is the largest producer of copper – although they make some fine carmenere wine as well! In fact Chile has over a third of global copper reserves and production (versus the second placed USA, which produces about 7% of the global total).

One day the copper will run out. But since 1985 the Chilean government has been putting aside its revenues from copper production in a sovereign wealth fund. Money is put aside when times are good and the copper price is high. Funds are then used to stabilise the economy during periods of weakness.

This fund now amounts to $22 billion. This is in addition to $40 billion of foreign exchange reserves. This is serious money for a country whose population is only 17.3 million people.

Government debt is just 12% of GDP and Chile enjoys the highest sovereign (country) credit rating in the region. This is reflected in bond yields.

Public finances are in good order. Government debt is just 12% of GDP and Chile enjoys the highest sovereign (country) credit rating in the region. This is reflected in bond yields. Ten year US dollar government bonds yield just 5.3%, against 9.7% in Brazil (Brasil).

GDP is growing at 5.7%, the unemployment rate is 6.2%, and inflation is low – just 1.5%. The central bank sets an official target for inflation of 3%.

Chile also claims that it has the highest number of regional and bilateral free trade agreements of any country in the world, at 57. In other words it’s a country open for business.

This country really stands out as a model of sensible economic and financial management in a region often plagued by political populism, debt defaults, currency devaluations, and raging price inflation. You just have to look at neighbouring Argentina to see all of those things on a regular basis (current estimates put Argentine price inflation around 25% a year).

…interesting aspect of Chile is that it has a well established pension system… ensures a deep pool of local funding for businesses, an essential part of a well functioning financial system.

One other interesting aspect of Chile is that it has a well established pension system. All workers must make monthly contributions into pension funds, which are then invested in local and foreign stocks and bonds. This system was set up in the 1980s, and ensures a deep pool of local funding for businesses, an essential part of a well functioning financial system.

(Again, this is a big difference to Argentina. The government there confiscated private pension funds in 2008, to “protect” them from the global financial crisis.)

So should you invest in Chilean stocks and shares? I’d say yes, at some point, but not right now. There are two main reasons for this.

The first is that the Chilean market is nowhere near cheap territory. There’s a reasonable dividend yield of 2.8%, but the country P/E ratio is over 20.

The P/E in Chile tends to have a higher average than most other markets due to the steady buying by the pension funds. But better opportunities come around from time to time. Back in March 2009, after the global market crash, the P/E went down to 12. That was a great buying opportunity.

The other thing to watch is the local currency, the Chilean peso. This is heavily affected by global sentiment towards commodity markets, especially copper. During the speculative commodities bubble of early 2008 it reached a point where the US dollar would buy 436 Chilean pesos in March 2008. A lot of speculators take bets on commodities through currency markets.

When commodities crashed, and global investors dumped all global risk assets during the financial panic of that year, the rate went all the way to 671 pesos to the dollar by November. In other words you could buy a lot more pesos with each dollar – the peso had lost relative value. That was a fall of 35% in just eight months.

Because local corporate earnings are in Chilean pesos this meant that stocks were affected by this currency collapse. But today the peso trades at 471 per dollar, not far off the peak in 2008. In other words there can be big short term currency volatility but the longer term risk is minimal. Especially given Chile’s strong financial condition.

Here’s a chart of the MSCI Chile index since April 2007, which is measured in US dollars. This means it shows moves of both local stock prices in pesos, and the moves in the peso itself, measured in dollars. You can clearly see the volatility around the global crisis in 2008.

MSCI Chile index

MSCI Chile index sin April 2007
MSCI Chile index sin April 2007

The index fell 45% between October 2007 and November 2008. But it then bounced as markets recovered. At the end of April 2013 level of 2,387 it is 115% above the 2008 low of 1,108 and 35% above the pre-crash April 2007 level of 1,770, six years ago.

In short, I like Chile in terms of economic fundamentals, but now is not the time to pile in. P/E ratios and the local currency are likely to offer much better entry points in future, the next time there is a global sell off.

Here at OfWealth we will be patiently watching and waiting for the right time. We’ll let you, our fellow OfWealth Thought Clubbers, know when we think that moment has arrived.

Until next time,

Rob Marstrand

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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.