Should You Invest in Brazil?

Tue, Jan 24, 2012 - 9:40am

I've just spent a very pleasant fortnight in Brazil. It's a wonderful country. But should we be investing there?

The first thing that struck me about Brazil is its sheer abundance. It's the fifth-biggest country in the world. It has 20% of the world's fresh water supply and just 3% of its population. (China has over 20% of the world's population and about 6% of its fresh water).

It has the highest number of species of primates, amphibians and plants in the world and the most diverse mix of races and cultures. An expansive coastline (4,655 miles) with Atlantic waves crashing down on mile upon mile of sandy beach; mountains; waterfalls; rainforest as far as the eye can see - you get the point.

I don't know what's stopping us all from moving there tomorrow. But should we be moving our money there?

Brazil Is not Cheap

The problem for an investor looking at Brazil now is its next most striking characteristic. It's not cheap. While pottering about Rio, with the exception of food, I kept thinking: "these are London prices". Accommodation, in particular, was dear.

It's expensive because the economy has boomed over the last decade, due to rising commodities prices and China's once insatiable appetite for 'things'. When an economy booms, its currency soon follows. Below is a chart of the Brazilian real. The pound has more or less halved in value against it since 2005: from 5.3 reals to the pound to a low a few months back of 2.5. So for a UK investor, Brazil is already twice as expensive as it was.

For now, the real has turned down against the pound. But it wouldn't surprise me to see that low of 2.5 retested. And I dare say it will be a long, long time before we see five reals to the pound again. A lot of 'secular trend changes' will need to happen first.

Brazil is not just expensive for foreigners - the locals have the same complaint. On top of this tremendous currency strength, in December inflation came in at 6.5%. Wages have failed to keep up, and house prices, for example, are beyond the reach of the average person (heard that one before?).

In general terms, I wouldn't touch real estate investment in Brazil. It's just too expensive. There are better opportunities in, say, Argentina next door. But if you were to ask me where I think the most money is going to be made in the coming years, I would say it's from the emergence and development of the favelas.

Once - but no longer - crime-ridden, these densely packed, low income communities are located on hillsides often right next to Brazil's most exclusive areas. Cantagalo-Pavão-Pavãozinho favelas, for example, overlook Ipanema and Copacabana. Favelas sprung up organically and in many ways are more beautiful than the bland apartment blocks you see elsewhere in the city.

(Cantagalo-Pavão-Pavãozinho favela - location, location, location)

Ownership of houses is gradually being 'officially recognized' and property is already starting to change hands. I overheard conversations as I walked through along the lines of "So'n'so bought his house for 4,000 reals (£1,500) five years ago and now it's worth 40,000 (£15,000)."

Priced out of other areas, the artists are already starting to move in. Over time the less adventurous will follow, as locals look to cash in on their house and move out. In many ways this is sad. Something unique will get lost - and no doubt all sorts of people will get ripped off as this trend unfolds - but that won't stop it unfolding.

In many ways it is similar to the sale of our own council housing, which began in the 1980s. I would personally avoid favela investment, mainly for practical reasons, but I have little doubt that one day favelas will be des res.

(Will shacks like this ever be des res?)

Brazil's Stock Market Is Stuck in a Rut

So what other opportunities are there in Brazil? Brazil has compelling demographics, with a young population and plenty of room for growth – which is what will drive prices in the favelas higher.

But essentially the country is a play on rising commodity prices. I still feel this bull market in commodities, which began at the turn of the century, has further to run. I'm a believer in the story that the middle classes in the emerging market countries are expanding, and that demand for things we take for granted in the West is only growing.

However, if China implodes, commodities will too and so will Brazil. Also, if we look at a chart of Brazilian stocks (as measured by the iShares MSCI Brazil index), you can see the big money was made between 2003 and 2008. Now I see an index stuck in a range, neither a compelling long-term buy, nor a long-term sell.

There seems to be some support at 55 and it could rally by 20% from here - but it's going to run into a lot of resistance in the high 70s if it does.

Globally, we are still stuck in in this 'risk-on / risk-off' rut. When investors feel upbeat, stocks, commodities, gold, Brazilian stocks – everything goes off to the races. Then investors get a reminder that there's a global financial crisis on, and everything gets sold off in a rush for cash – usually the yen or the US dollar.

It's very hard to select individual areas of growth when there is such an over-riding investment headwind at work. However, I see opportunities in the following areas. Firstly, early stage projects in mining, energy and agriculture (these carry their own type of risk, however).

Secondly, infrastructure (the 2014 World Cup and the 2016 Olympics are being held in the country) and communications - Brazil loves the net, but connection was frequently intermittent, slow and unreliable. And thirdly, tourism - more and more people are going to come here on holiday, which will be another driver of infrastructure development.

The simplest way to invest in Brazil is via that iShares MSCI Brazil exchange-traded fund (ETF) (NYSE:EWZ). But this is very dependent on commodities – approximately 18% of the ETF is inPetrobras (NYSE: PBR) and another 14% in mining giant VALE (NYSE: VALE).

So a better bet for those interested in potential opportunities in infrastructure would be to investigate the EG Shares Brazil Infrastructure ETF (NYSE: BRXX). This includes stocks within the telecoms, utilities, and road building sectors.

My latest gold report is now available – as well as looking at ways to buy gold itself, I’ve also tipped some speculative mining stocks that I think are poised to do very well in the coming years, and provided some updates on my previous tips. Get your copy of my gold report here.

This article first appeared in Money Morning, the free daily investment email from UK investment magazine, Moneyweek. Sign up here - it's free.