Commodities to Power Emerging Markets Higher

In Latin America, Brazil leads as a natural supplier of copper and crude
oil, which it is now able to extract and export on competitive terms.
Nations rich with natural resources perform well during times of global
economic expansion. In particular, countries rich with industrial
commodities tend to outperform those without.

While the European debt crisis and slow growth in the U.S. has decreased
demand in these economies, global demand is still strong due in large
part to high growth rates in China and developing economies. Latin
America also benefits from a lower unit labor cost helping to lower
total production costs as a coupled with a more relaxed regulatory
infrastructure and low-inflationary environment.

The combination of a natural supply, and low cost, is driving demand
from countries, like China, into Latin America. The natural result is
Latin America’s own economic expansion. For the next few years China
will continue to grow at a range between 6% to 8%, as less developed
emerging economies, such as Vietnam, are likely to expand by more than
double that rate. It is the strong growth in these markets that will
drive demand for the goods and services of Latin American countries for
the next five to ten years.

The height of U.S. demand for copper and other industrial products
occurred during the U.S. housing boom from 1997 to 2006. During the
boom, copper consumption in the U.S. more than doubled, topping out at
7,660 million pounds in 2005. With a strong housing market driving
economic growth, the U.S. economy grew GDP at an average rate of 3.3%
during this time, and the leading exporter of copper to the U.S., Chile,
experienced GDP growth at an average of over 4%.

In addition, Chile’s trade-surplus skyrocketed to over USD 20 billion
by 2006, more than doubling the surplus from 2005. This same year, at
the peak of the housing bubble in the U.S., Chile’s exports of goods
and services increased 41% year over year (with 42% of exports going to
the United States) due, in large part, to rising prices for copper.

In examining the U.S. – Chile example, the drivers of growth were 1) a
country with extremely strong demand for a good; and 2) a nation with an
abundant supply and access to the good.

These factors were supported by an established trading relationship and
an imbalance in competition of other providers of the good. During the
housing bubble, the U.S. demand for copper grew so exorbitantly that
current production capabilities and imports from other countries could
not meet its demand. Chile met the demand and the boom for both
economies followed.

With the world’s largest population, a burgeoning middle-consumer
class and a government supporting economic expansion, China’s current
production capabilities and natural resources cannot meet the demand of
its development. As China completes its shifts from an agrarian society
to an industrial one, the demand for industrial commodities will only
increase. Latin American nations are already trading extensively with
China (China is Chile’s largest trading partner) and thanks to
abundant natural resources, including industrial commodities, this
relationship should continue to develop.

China consumes 40% of the world’s copper and meets its demand
primarily through importing copper from Latin America. Over the past few
decades, the amount of copper China consumes has grown each year and is
likely to continue for at least the next five to ten years.

For example, in December of 2011, China imported more than 500,000 tons
of copper, which amounted to a 47% increase from December 2010. It is
estimated that in 2012 China will consume 6% more copper than in 2011,
but there is a strong case that growth will continue or exceed the pace
of the past few decades. Since 2000, China’s consumption of copper has
grown at a rate of 15.1% annually. Along with demand for copper, China
depends on imports for iron ore, steel, and oil.

Latin America produces over a third of the world’s copper. This is
primarily produced by Chile and Peru, but other nations, such as Panama,
are rich with the industrial commodity and currently working on mines to
extract the metal. Brazil, which boasts China as its largest trading
partner, is the lead exporter of iron ore and crude oil in Latin
America.

While an argument could be made for many of the countries in Latin
America to rise from the development occurring in China, Brazil, with
the already established trading relationship, supply of industrial
commodities, and strong government pro-trade policies, is a prime
example of a Latin American country positioned to experience significant
growth through its trade relationship with China.

In the 10-year period ending in 2010, Brazil’s exports to China grew
by more than 35%. During this time, Brazil’s GDP grew at an average
rate of over 3.5%. Going forward, Brazil is positioned to strengthen its
relationship with China and should see continued growth.

Key companies in Brazil, including Petrobas, are undergoing exploration
initiatives that are uncovering more oil reserves and adding to
Brazil’s economic position. One such discovery occurred in 2006, when
Petrobas discovered the Tupi oil field. The Tupi oil field contains
between 5 billion and 8 billion barrels of oil and is the second largest
field discovered in the past two decades. It is perhaps the most
important discovery to Brazil’s economic development in this century.
The Tupi oil field will increase Brazil’s oil reserves by over 60% and
push it into a premier oil-exporter. By discovering the Tupi oil field,
and other small fields across the country, Brazil has gained bargaining
power it previously did not have with China.

Being in a stronger position is allowing Brazil to benefit from the
Chinese demand without sacrificing its own economic initiatives or
position. In January of this year Brazil President Dilma Rousseff and
Chinese Prime Minister Wen Jiabo came to terms on an agreement that will
expand the trade relationship and joint-investments between the nations.

The agreement, called a “Common Agenda of Investments in the Mining,
Industrial, Aviation, and Infrastructure Sectors” will encourage
commerce between Brazil and China and establish the framework for trade
and direct investments into each country. The agreement will promote
trade between the countries and allow Chinese companies to directly
invest into Brazil’s oil and manufacturing sectors. This next phase of
Brazil-China relations will act as an additional level of support for
Brazil’s growth in the coming years.

Countries in Latin America recognize that their economic growth is tied
to their natural resources. For this reason, many have spent the last
decade investing in the ability to extract these resources and transport
them internationally.

In Panama, the government is investing in such infrastructure at an
astonishing rate – increasing spending by 41% year over year from 2010
to 2011. This spending is going to projects such as the development of
mines and mining equipment, roads to transport goods, and ports to ship
them. But a large part of it is going to the Panama Canal expansion
project. Recognizing that the Panama Canal would soon not be able to
handle demand, in 2006 Panama began a project to expand the canal to
accommodate future traffic. This project will allow larger ships to use
the canal and increase revenues to Panama. When the project is completed
(estimated 2014) the canal will be able to handle double its current
capacity. Panama asserts that the expansion of the canal will by itself
generate enough wealth to transform Panama into a First World country
while reducing national poverty levels from over 30% to below 8%.

In addition to the benefits to Panama, the canal expansion is extremely
important for the rest of Latin America as it will make the shipment of
goods easier for these countries and allow them greater access to
international trade. In addition to this project, Panama is home to two
of the world’s largest underdeveloped copper deposits, which are in
the process of being developed into mines.

The case for growth in Latin America is strong. Rich with industrial
commodities, countries like Brazil, Peru, and Panama, are in a great
position to benefit from industrial expansion in China and other
emerging markets. As China and emerging markets continue to demand their
commodities, they should be able to access the cash necessary to
continue their own infrastructure development.

Over time this development will push these countries into the developing
world, reduce unemployment, and plant the seeds for growth of a domestic
consumer base. As we’ve seen in China, this process takes time, but
with the appropriate mix of governmental policies, and foreign
trade-relationships there appears to be no limit to the future of these
Latin American economies.

*Post courtesy of Dawn Bennett, the fund manager for the Bennett Group of Funds.

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