How you can profit from Argentina’s twisted economy
This weekend, I spent a very surreal hour with an old Argentinian friend. I watched him unpack the brand new laptop and iPad that he’d bought in London and start smearing them with traces of dirt and food.
Then he got a cable and installed loads of old files and photos, filling up the desktop in a jumbled mess of half sorted folders. Finally, he started mucking around with dates on the operating system. After a while, the laptop and iPad looked as good as old.
Why did he do it? Because he was about to fly back to Buenos Aires, where customs officials slap a fat tax on expensive new imports. He’d seen them open up cases, turn on computers and even start reading through files. And that is why he wanted to make sure his brand new gear looked as used as possible.
“Of course, it wouldn’t take long for a computer expert to work out that it’s new”, he admitted. “But hopefully it should be enough to fool them.”
My friend’s extraordinary behaviour is a reaction to Argentinian president Cristina Kirchner’s attempts to micromanage people’s spending habits. In the last few years, Argentina’s government has restricted imports, either through tariffs or quotas, to ensure that its exports balance its imports.
In doing so, it has pushed up local prices of imported kit such as laptops, and made people like my friend even more desperate to get their hands on them. Aside from the time wasted on both sides of this game of cat and mouse, the micromanagement also creates major distortions.
A twisted economy
One of the most obvious distortions is the exchange rate. The government has an official rate of 5.8 pesos to the US dollar, which is what you’ll get from banks or at an official bureau de change. But in the black market, a dollar can get you closer to ten pesos.
The reason for the difference between the rates is that the government is determined to restrict capital flight, ie, pesos becoming dollars, while locals are determined to protect the real value of their wealth by transferring it into a more solid currency.
The more difficult the government makes it for Argentinians to turn pesos into dollars, the more they want to do so. It doesn’t help that many parts of the economy – for example, the real estate market – don’t trust the peso, and demand dollars.
Again, these distortions produce strange behaviour. For example, another friend of mine works for an NGO in Argentina. The situation is so bad that his boss has to take the office’s monthly wage packet, which arrives in dollars, to a black-market contact to get a decent exchange rate.
“You wouldn’t expect us to be doing something illegal, but if we didn’t, our pay would be worth peanuts.”
There are lots of historical reasons why Argentinians don’t want to hold pesos. One of the most striking was the 2001 Corralito, when overnight, the government froze dollar bank accounts and only allowed withdrawals in pesos.
Within months the exchange rate had gone from one peso to the dollar to four pesos to the dollar, leaving a lot of disgruntled peso holders.
But there’s also a much more pressing reason. Right now, Argentinian inflation is running at around 25% per year. I say ‘around’, because no-one is really sure how high it is.
The government’s official statistics put it at 10%, but no-one, not even the government, really believes that. So, with inflation churning through a quarter of the real value of their wealth each year, Argentinians are understandably keen to find another way to store it.
The reason for this madness
One of the biggest problems in Argentina is energy. Despite the fact that the country is laden with great oil and gas deposits and considerable local know-how, it is set to import around $10bn-worth of energy per year.
Financing those imports – Argentinian energy is subsidised, so the government picks up a large part of the bill – is one reason why Kirchner is so busy trying to micromanage my friends’ spending habits.
A few years ago, I spent about five months in the country writing a report on its energy sector for a US oil magazine. Every private-sector interview was the same.
When the voice recorder was on, they would mumble a few platitudes about working with the government, but when it was off, they would bitterly complain about the stupidity of the situation.
Firms were being forced to sell oil to the local market at artificially low prices. As a result, they weren’t bothering to invest in bringing on new production.
As one of them put it to me: “This government doesn’t seem to understand that we’re a multinational company and deploy our capital where it suits us best. Right now, there are far more exciting opportunities elsewhere.”
A dead cow brings hope
But there is room for optimism, because there are signs that policy is starting to shift. Struggling to cope with the widening energy deficit, Kirchner has allowed producers to sell gas for higher prices.
Meanwhile, a recent decree allows producers to sell 20% of their oil and gas abroad – ie, for higher prices – as long as they invest $1bn in the country.
In a bizarre twist, she is even helping Chevron fight claims being made against it in the Argentinian judicial system by Ecuadorian lawyers.
That’s quite a turnaround given that normally Kirchner and Rafael Correa(Ecuador’s president) are allies against the US. In short, in her own awkward way, Kirchner has realised that she needs international investors.
Meanwhile, the international investors realise that they need her too. Despite all the condemnation when the government expropriated the assets of Spanish oil firm Repsol, other oil companies have been quick to forgive and forget. (A quick hat-tip to my colleague, John Stepek, who predicted as much last year.)
Indeed, we have seen major international investors such as Chevron and Cnooc, which is China’s third-largest oil company, rush into deals with Argentina. Because regardless of the problems, it still has incredible potential.
According to the United States Energy Administration, Argentina has the world’s second-biggest shale gas deposits and the fourth-biggest shale oil deposits. In fact, the Vaca Muerta (dead cow) oil field is seen as one of the industry’s most exciting prospects.
If Argentina could reverse its energy deficit, the effect on other parts of the economy would be startling. The government would have less need to control capital flight, it would have more money for infrastructure investment, and consumer spending would receive a boost.
Capital Economics believes that it could lift Argentina’s growth to around 5%. Who knows, maybe my friends could even stop trying to disguise their laptops.
Another positive factor could be political change. Kirchner’s Frente para la Victoria party suffered during recent mid-term elections. She still has a majority, but it is not enough to change the constitution to give her a third term. That raises the prospect of a new president in 2015.
On its own, this wouldn’t be enough for me to invest. Two years is a long time in politics, and it’s still far from clear what will happen. But on top of the positive factors mentioned above, it’s also a nice source of additional potential uplift for investments.
Will you put your money on the table?
Of course, at the moment all of this is still dependent on a lot of ‘ifs’. Sure, Chevron and Cnooc are prepared to put their money down, but are you?
So far, the Argentinian companies I’ve talked about have done pretty well. Steel producerTernium (NYSE: TX), which is listed in Argentina, but does a lot of its business elsewhere in Latin America, is up 30% since I tipped it last year.
Most of this rise is down to its other business units, but no doubt an improvement in its home market would help further.
Another strong performer is Argentinian farmer Cresud (Nasdaq: CRESY). It’s up 23% since I mentioned it back in April. In addition to farmland, it also has an extensive real estate portfolio, meaning that it’s exposed to an uptick in the general Argentinian economy.
In the months after I wrote about it, the ‘Argentinian e-Bay’ rose by 10%. But then disappointing third-quarter results earlier this month led to a big sell-off.
Investors were disappointed with profit margins, but ultimately, the firm’s bull points remain in place. Namely that it has a leading position in online retail, which is a fast-growing sector in Latin America.
Again, an uptick in the domestic economy would be a big boost for the firm, and with the stock presently trading for a good price, this is a stock that is well worth keeping an eye on.
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