Commodities to Power Emerging Markets Higher
Bennett Funds
By Dawn Bennett
August 13, 2012

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.

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Dawn Bennett is the fund manager for the Bennett Group of Funds http://www.bennettfunds.com and founder and CEO of Bennett Group Financial Services.