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Ex-Economist writer-turned money manager and market commentator Vivian Lewis of Global Investing cited a recent quote from former CNN journalist Frida Ghitis to highlight the investment potential of Colombia:
“Colombia, where I was born, is slowly emerging from a drug-fueled war that lasted decades. The future looks bright. Dodging a regional trend, Colombia’s democratic institutions survived a hyper-popular president who could have held on to power. Its just-completed elections were won by a competent technocrat against a flashier charismatic challenger. President-elect Juan Manuel Santos, who studied economics at Harvard and the London School of Economics (no guarantee of anything) will continue Uribe’s business and security focused policies. Colombians are repatriating their cash. And foreign investment that might have gone next door to Venezuela, spooked by Chavez will head to Colombia. Santos will be good for the economy and investors.”
Per the performance of GXG (above), the ETF based on the FTSE Colombia 20 Index, there have been far worse places to have been invested in the past 10 months. As eager investors continue to rush to the peso (see USD/COP, below) domestic borrowers are getting in on the act. Earlier this week Bancolombia, the country’s largest lender, sold $620 million of subordinated bonds after boosting the size of the offering by $20 million. The 10-year notes pay a spread of 337.5 basis points, per Bloomberg.
As The Economist hinted in late June, there can be renewed optimism about Colombia’s future if for no other reason that commentators are now far more focused on its economy than the once-bustling drug trade (see graph, inset) and the once-thriving contingents of FARC and ELN guerillas terrorizing at will.
However, that isn’t to say that the underlying economy isn’t without its own host of problems:
“At home Mr Santos faces a bankrupt health system, a persistent budget deficit and an unemployment rate of 12%, one of the highest in the region. He promises to balance the budget by 2014 without raising taxes, and to cut unemployment to single digits. He says this can be done by reforming health care and reducing transfers of oil and mining royalties to the provinces. He has been cagey about reforming archaic labour laws that condemn most Colombians to the informal economy.”
According to analysts with RBS Securities Inc., the decline of Colombia’s peso in light of Venezuelan President Hugo Chavez’s threat to freeze imports because of the country’s alleged cozy ties with U.S. “imperialists” may have more room to run in fact, given that the ascendancy of the world’s best performing currency YTD had come too far and too fast for the Central Bank’s tastes. Per Bloomberg reports, Colombia’s Agriculture Minister Andres Fernandez admitted last week that exporters such as coffee growers were vigorously urging the Bank to buy dollars in order to weaken the peso. That said, while a continued sell-off will inevitably hurt asset prices across the board, analysts warned of an overshoot. “We believe these episodes tend to elicit exaggerated reactions and do not affect underlying trends in a lasting manner,” said one.
If the IMF (International Monetary Fund) is to indeed realize increased influence over international finance, byway of offering defacto crisis insurance that will allow developing countries to not necessarily hoard so much currency reserves, then the stigma of approaching the organization will have to disappear, and moreover investors will have to collectively not punish the prudence of such credit-tapping. Today, for example, Colombian bonds rose, pushing yields to the lowest in more than two years, as the government is seeking a $10.4 billion credit line from the IMF. “There is confidence in the local market because we have multilateral support,” said Adriana Botero, an analyst with Acciones y Valores, a Bogota-based brokerage. Per Bloomberg, Colombia doesn’t plan to tap the IMF’s credit line and will only use it should the global slump worsen. But there mere fact that investors didn’t flee upon the news that heads of the central bank and the Finance Ministry had been in Washington meeting with multilateral lenders is a positive sign for other emerging and frontier economies that may need such assistance in the future.
As inflation fears temper and interest rates decrease, Colombia may begin to sell debt due in 2024 or 2029 by June, according to its head of local debt sales at the Finance Ministry. Citing increased demand from pension funds and insurers for longer maturities, William Ortiz noted that the country’s foreign debt is rated BB+, one level below investment grade, by Standard & Poor’s and Fitch Ratings. Meanwhile, Moody’s Investors Service rates the nation one grade below investment quality at Ba1.
The Banco de la Republica cut Colombia’s benchmark rate a half percentage point to 9.5% on Dec. 19, marking the first rate cut in three years. And most analysts expect the central bank to cut the rate again at a Jan. 30 meeting, to 9%. Reacting to the news, markets pushed benchmark yields to 18-month lows. The yield on the benchmark bonds due in 2020 fell to 9.71 %, the lowest since July 2007. “At least until last year, the search for yield and expectations of a weakening dollar led foreigners to have more faith in the value of the peso than locals did,” said Alberto Bernal, head of emerging-market macroeconomic strategy at Bulltick Capital Markets in Miami.
Kudos to Tom Lydon for returning my gaze back to coffee, which along with cocoa, is one heck of a tasty commodity to track.
Lydon cites Bloomberg’s Claire Leow, who reported on Tuesday that world coffee consumption may outstrip production by as much as 8 million bags in 2009-10 because of the smaller crop in Brazil, the world’s top grower:
Prices of the mild-tasting arabica coffee used by Starbucks Corp. jumped 6.1 percent yesterday, the biggest gain in almost three years as Brazil’s Agriculture Minister Reinhold Stephanes said output may drop as much as 22 percent next year to as low as 36 million bags. Prices of the bitter-tasting robusta used in espresso and instant coffee by Nestle SA climbed 4.3 percent.
Interestingly, coffee has outperformed commodity indexes since prices plunged at the end of June. Arabica has dropped 29 percent in New York, for example, compared with a 61 percent slump in the S&P’s GSCI index of 24 raw materials. Leow’s report mentions, by the way, the other two coffee exporters of note–Colombia and Vietnam:
Colombia was expected to produce 12.5 million bags, “but rains may have reduced that by 200,000 to 500,000 bags. Good management practices will keep the crop at between 12 million and 16 million bags in coming years, said [Nestor Osorio, International Coffee Organization Executive Director].
“Vietnam isn’t losing very much because the industry is still young and the trees have strong yields,” he said, estimating the current crop at 21 million bags. Output in the next three years may stabilize at 18-20 million bags, he said.
Finally, the iPath Dow Jones AIG Coffee TR Sub-Index ETN (NYSEArca: JO) is down 24.8% since inception. It, along with the other soft commodity funds from the iPath family, is arguably a prudent play, especially if you buy into the Jim Rogers’ secular commodity hype that reasons that the world is only getting bigger, and demand can only outpace supply in the long run.
Frontier markets are smaller, more undeveloped and riskier than emerging markets, and Friday index provider MSCI Barra announced that not only will it consider upgrading Kuwait, Qatar and the United Arab Emirates to emerging markets from frontier markets (expect a final decision by June 2009), but that it will further consider downgrading Argentina and Colombia to frontier markets from emerging markets “unless significant improvements in the relevant capital flow restrictions are observed” by December (despite Moody’s announcement that Colombia’s debt rating will be raised just one notch below investment grade). As far as definite downgrades, MSCI said that it will reclassify Jordan to a frontier market from its current designation as an emerging market starting this November, because of the small size of the nation’s market and the lack of liquidity.
More than $3 trillion is benchmarked to the MSCI International Equity Indices, and the MSCI Emerging Markets Index is one of the most widely used indices to gauge the performance of emerging equity markets. The iShares MSCI Emerging Markets ETF tracks the performance of the index.
Vis a vis the hopelessly stalled Colombia Free Trade Agreement (FTA), Democrats in Congress still hold their collective noses at Colombia’s appalling human rights record (though some would argue that any high ground the U.S. had on that issue was regrettably thrown away, circa 2001), as well as the claim that Colombia’s government is hostile to labor unions (citing union members’ deaths at the hands of paramilitaries as evidence). Furthermore, before even considering the deal, Democrats would like Congress to first pass legislation to help those here who would lose their jobs because of “shifting patterns of trade.” In the meantime, Colombia remains a class divided country (the gap between the rich and the poor in Colombia is one of the biggest in Latin America, with the top one-fifth of the population retaining 60% of the national income, according to the World Bank) of 44 million, now in ‘trade limbo.’
The United States for years has regularly renewed its preferential tariffs on nearly all Colombian exports, and in 2006 Colombia agreed to drop its barriers to American goods, as well, in exchange for the arrangement being made permanent (hoping, in turn, that said deal would create a new wave of inward flowing capital). Now, that arrangement looks doomed, and with it could go the political fortunes of its leader, Álvaro Uribe, who is in his second term and who has been considered over the years to be a staunch ally of the U.S. in the fight against the drugs and terrorism trades which have constantly threatened to engulf the poor country.
This is an issue to keep an eye on in terms of guaging investors’ future sentiments towards the nation as a whole. Back in February, Ben Laidler, a strategist at JPMorgan Chase, stated that Colombian equities “could positively surprise” in 2008, and that “key catalysts would be the lifting of capital controls, as well as strong economic growth, attractive stock valuations, the low level of foreign participation in the equity market and the recent listing of state oil company Ecopetrol.” But what kind of growth would follow in the event that the FTA falls through? Critics of the Democrats’ alleged politically driven protectionism argue that Uribe should ignore the petty interests of US politics, and negotiate actively other trade liberalization agreements with the European Union and the Pacific rim. But losing the U.S. would surely takes its toll, especially in light of other economic factors weighing against it.
Free trade aside, to many, Colombia (and pretty much all of Latin America) has never looked riper. Interest-rate cuts in the U.S. have prompted a number of investors there to buy higher-yielding Latin American shares and bonds (although fears of inflation are increasing, and Colombia’s central bank, along with Chile’s, missed its inflation target). The lawlessness and drug trafficking that has forever been associated with the country was somewhat tempered by Uribe and a tough security policy that greatly weakened Colombia’s left-wing FARC guerrillas who once ruled the countrysides with relative ease. “The fundamental backdrop has improved significantly in recent years, driven by a dramatic turnaround in the country’s security situation and the center-right reformist presidency of Alvaro Uribe, the most popular major leader in the region,” Laidler said.
However, cynics wonder how entangled the government still is with rogue groups. “Paramilitaries” were created in the 1980s by wealthy ranchers to protect themselves from FARC attacks. But over time, and especially in light of FARC’s waning power, said groups have turned into defacto warlords, accused of killing thousands in the name of drug trafficking and money laundering. They also may have deep-rooted political ties. In 2006 a senior paramilitary leader boasted after the 2006 election that a third of Congress’ members were elected with his movement’s backing. And last month Mario Uribe, the president’s cousin and close political ally, was arrested for his allaged paramilitary links. Yet Uribe seems genuinely keen on a nationwide crackdown, especially after the recent announcement of th extradition to the U.S. of 14 of Colombia’s most sought after paramilitary warlords on drug trafficking charges. But, goes the counterargument, might this have been only to hush up the men with the most information about illicit-government links, as well as to get in good graces with U.S. Democrats?
Back to the numbers. Colombia’s economy grew by about 7% last year and is expected to grow by 5.5% this year, although unemployment is still around 11.5%. Its top three exports are oil, coffee and coal; other exports include nickel, emeralds, apparel, bananas and cut flowers. One primary concern to investors should be its sparse capital flows. According to fund tracker EPFR Global, during the best month of 2007, inflows totaled $34 million, while during the worst month outflows were $15 million. In comparison, regional neighbors, like Brazil, receive hundreds of millions of dollars of foreign inflows. One glaring problem was that in May 2007, as unproductive capital flows caused the artificial appreciation of the Peso and put pressure on some exports, the government imposed a 40% non-remunerated, six-month deposit requirement on all short-term foreign inflows. For example, Geoffrey Dennis, an equity strategist at Citigroup, reiterates that capital controls drag down Colombia’s equity market, but states that “their removal could catalyze equities to outperform.” Also hurting the local market, he says, are rising fiscal and current account deficits, and unattractive equity valuations. And “once capital controls are lifted, we would focus on growth stocks, such as beneficiaries of infrastructure spending,” Dennis stated. However, it’s questionable whether or not this policy change will ever happen, especially given the government’s well founded concerns over inflation.
Despite the red flags, Laider has specific plays in mind for those interested in the present. After all, the IGBC Index–the benchmark index of Bogotá’s (pictured) Bolsa de Valores that holds rapidly growing components such as Bancolombia and Chocolates–has surged nearly fourteen fold since its October 2001 low. The three biggest and most liquid stocks, he says, are the aforementioned Bancolombia (CIB), the country’s largest bank and Colombia’s only level three ADR, as well as Ecopetrol and Suramericana, a conglomerate with stakes in the insurance, social security, finance, cement, food, retail and textile sectors.
JGW
Frontier Markets 