THE NEW BACK DOOR TO CHINA
by Martin D. Weiss, Ph.D.
Editor, Safe Money Report & MoneyandMarkets.com
April 2, 2007

This weekend, Elisabeth and I finally got away to our favorite spot — the smallest, most beautiful, semi-private beach in the southern State of São Paulo.

I’m glad. It gives me a chance to contemplate the escalating Persian Gulf crisis from afar, something our editors and I talked about intensely before I left home late last week.

Plus, it gives me a chance to survey the opportunities here.

The beach is so small, it takes only five minutes to cross, wading casually through the shallow pools of warm ocean water. And on either side, rolling cliffs rise from the sea, covered by the tropical Atlantic Rainforest.

If we drive just a short distance inland, however, the scenery changes dramatically — from coastal tropics to temperate highlands; from seascape to skyscape.

We come to the nearest major city, São José dos Campos — headquarters of Embraer, the third largest aircraft manufacturer in the world.

And as soon as we approach the nearby concrete jungle, my mind turns to the larger drama now unfolding in Brazil ...

Booming Trade with China

Nearly everywhere I look, I see direct or indirect signs that Brazil is the new back door to China.

Last September, for example, Embraer’s stock, which trades on the NYSE as ERJ, soared with the news that the company would sell 100 regional jets to China’s Hainan Airlines for $2.7 billion.

And just two months ago, Embraer soared again, spurting from $39 per share to over $46.

I first mentioned the company here in Money and Markets in late 2004. Since then, the stock has nearly doubled, with big aircraft orders from countries like China acting as a major catalyst.

But China’s impact on Brazil is certainly not limited to the aircraft industry.

Quite to the contrary, figures just out last week show that, in the first 11 months of 2006, Brazil was China’s largest trade partner in Latin America.

Meanwhile, bilateral trade between China and Latin America as a whole seems to be doubling every five years: It was $50 billion in 2005. It will hit $80 billion this year. And it should easily reach $100 billion by 2010.

So for the past several years, new Sino-Brazilian ventures and deals have been in the news almost daily.

Just last week, for example, Chinese investors rushed to join Farias, a major sugarcane group in northeast Brazil, to build new ethanol mills.

Why the hurry? Because in recent months, Asian investors, like Japanese trading companies Mitsui and Itochu and India’s sugar giant Bajaj Hindustan, have been scouting out Brazil’s booming ethanol sector. So Chinese investors, loathe to be left behind, are trying to jump ahead of their Asian competitors.

Three major factors are driving this:

First, the time is right. As I told you last Monday in “War of Blackmail,” escalating tensions with Iran are already driving up world oil prices. And even before the new price surge, there’s a sustainable, pressing demand for alternatives to crude as long as crude holds over $40 per barrel!

Second, the place is right. Brazil is the world’s number one producer and exporter of sugar. It’s the world’s number one producer of sugarcane-based ethanol. And this kind of ethanol is the world’s least costly to produce.

Third, the technology is right. Just recently, in the neighboring state of Mato Grosso, Brazil’s president, Luiz Inácio Lula da Silva (Lula), inaugurated the world’s first plant that makes not only ethanol from sugar cane and biodiesel from soybeans ... but also electricity from bagasse.

Suddenly and unexpectedly, Brazil burst on to the scene as the world leader in ethanol technology.

That’s why Lula and President Bush are putting their muscle behind their joint proposal to export Brazilian ethanol technology to Central America and the Caribbean. Entire plants, like the one just inaugurated in Mato Grosso, are likely to be shipped north, lock, stock and barrel.

And that’s why I’ve been continually stressing the importance of sugar cane-based ethanol here in Money and Markets. (See especially “President Bush launches new ethanol boom!” and “Ethanol Explosion! How to Profit.”)

If you haven’t done so already, it’s time to start paying attention.

A New Brazil

Ever since Lula was first elected president five years ago, naysayers have said he would wreck Brazil’s economy.

But he has done precisely the opposite, implementing the most disciplined fiscal and monetary policy the country has seen in half a century.

He has boosted Brazil’s currency by 69% since he took office in January 2003. He has transformed a massive trade deficit into a massive surplus. And he has paid off 100% of Brazil’s debts to the International Monetary Fund.

To achieve all that, however, Brazil had to pay a stiff price: Spartan government spending, sky-high interest rates ... and, consequently, slower economic growth than countries like China or India.

So it’s only now, in Lula’s second term which began three months ago, that he’s got a firm enough financial foundation in place to go for the real prize: Big growth.

With that goal in mind, the Bank of Brazil (the equivalent to our Fed) has already slashed its benchmark interest rate 14 times. And sure enough, the economy is responding:

Retail sales have just jumped 8.5%.

Capital goods production has jumped 18%.

And the ETF tied to Brazil’s leading stock index, the iShares MSCI Brazil Index (EWZ), has risen 50% since January of last year.

We’ve Been Hoping for This for a
Long Time. Now It’s Happening!

Elisabeth and I were married in Piracicaba, also in the state of São Paulo, back in August of 1969.

And we’ve been hoping for this kind of a situation ever since.

On that day 38 years ago, for example, Brazil’s giant aircraft manufacturer, Embraer, had just been created by the Ministry of Aeronautics. The company was barely one month old.

I saw the news about the new company and watched it closely. But no one, myself included, could have dreamed Embraer would one day become a major exporter (let alone to China!) ... that its work force would grow to 20,000 ... or that its shares would be traded on the New York Stock Exchange.

I could also not have anticipated the fact that:

• Brazil’s currency is one of the strongest in the world. Forty years ago it was one of the weakest in the world.
• Brazil would someday become a major energy exporter. It hasn’t happened yet. But it will. And already, we see a huge contrast to the old days, when higher oil prices were so devastating to Brazil’s economy.
• Investing in Brazil is as easy as buying a U.S. blue-chip stock. Thirty-eight years ago, unless you were a resident, it was extremely difficult to invest in Brazil. Today, not only are there many companies like Embraer that trade on U.S. exchanges, but you can buy EWZ, the exchange traded fund linked to Brazil’s major stock index, as easily as you can buy any U.S. stock.

Rising Tide of Conflict
In the Persian Gulf

In this peaceful setting on Brazil’s southern shores, you’d think I could forget, at least for a few days, the disturbing events now unfolding on the other side of the world. But I can’t. They’re too intense — and too important.

Especially vivid in my mind is the conversation I had before my departure — with John Burke, Weiss Research’s defense stock specialist.

John is a Jarhead, the nickname Marines use for their fellow brothers in arms. He trained in desert, mountain, and jungle warfare. He became a security and intelligence specialist. So when he left the Marines and entered the world of investing, it was only naturally for him to specialize in what he knew best — security and defense.

Before I left for the airport, I asked John a series of questions about his view of an armed conflict with Iran and its potential impact on investors. His response:

“Even if the latest hostage crisis is resolved, it’s going to be tough to avoid.

“Iran’s operatives are swarming all over southern Iraq. Iran has exported insurgency to the Palestinian Territories, Lebanon and other hot spots in the region. Iran’s nuclear program has crossed a tight line in the sand drawn by the United Nations. Each of these processes has a life of their own. It’s going to be very difficult to reverse them.

“Expect an air war and surging oil prices. Then, immediately thereafter, expect a new surge in defense spending in the U.S. and in the region.

“If you think the president’s supplemental budget requests are large, wait till you see the mammoth budget requests that are bound to be made in the wake of an Iranian conflict.

“And don’t forget: The U.S. government is one of many. Even without a broader war in the Persian Gulf, Saudi Arabia already increased its U.S. military procurements by 238% last year — to a whopping $9.7 billion.

“Nearby Pakistan upped its procurement of U.S. arms by an astonishing 1,840%.  

“Even small Persian Gulf States like Bahrain and Oman have doubled U.S. arms purchases — or more — in the past year.

“The impact on defense stocks from escalating world conflicts like these is unmistakable: Between 2000 and 2006, while the S&P 500 lost 3.5%, defense companies gained 114%. And from 1990 to 2006, despite 12 years of peacetime and three years of down markets, investors in select defense companies have made a fortune.

“Lockheed Martin investors saw gains of 147%. General Dynamics investors saw gains of 271%! And Northrup Grumman investors saw gains of 516%.”

Elisabeth nudged me, reminding me it was time to leave. Morning traffic. Security at Miami International. Everything could take more time than expected.

I asked John one last question: “We already know about these large defense companies. What I want to know is when can you give us research on companies in the forefront of this defense boom that most investors don’t know about?”

He promised to have it to me shortly, and I promise to share it with you as soon as he does.

Good luck and God bless!

Martin

© 2007 Martin D. Weiss, Ph.D.
Editorial Archive

CONTACT INFORMATION
Weiss Research, Inc.
15430 Endeavour Drive
Jupiter, FL 33478
Email  |  Website