My Top Emerging Market in 2009

One country is gaining a head of steam to deliver huge gains in 2009.

Don't let tame year-end trading fool you... Brazil is about to break out.

On any given day, you probably hear more about the three other countries in the BRIC group of top emerging markets―Russia, India, and China―than you do about Brazil.

But within just the past couple of months, we've seen these headlines coming out of Latin America's top economy:

• "Brazil's Lula Calls for Shake-up of Global Finance"

• "France Backs Brazil for Security Council Seat"

• "Brazil as a New Kind of Oil Giant"

They didn't get much play, but these news stories have big consequences for the global economic leadership and investors who want to maximize international stock gains.

Brazilian Strength in 2009

First off, you must understand that as a nation, Brazilians have known terrible times. Military dictatorship and economic stagnation are recent memories for even the most prosperous in that sunny country, and there are still tens of millions of Brazilians who live on less than $1 a day.

Horrible handling of money affairs also put Brazil under the financial planning eye of the International Monetary Fund. In order to ensure repayment of loans issued by the World Bank, the IMF sends experts to countries like Brazil. They impose austerity in public spending and tamp down inflation by limiting wage increases, which often draws the ire of labor unions and non-governmental organizations.

In recent years, though, developed countries that used to preach responsible accounting to Brazil have fallen on their faces in a flurry of tricky accounting maneuvers.

Brazil notices, and President Luiz Inacio Lula da Silva is rightly pointing out the irony that Brazil is now an island of financial stability.

"Important banks - very important banks - that spent their lives giving advice about Brazil and what we should or shouldn't do are now broke," Lula told a rally in southern Brazil in September.

"Brazil is more prepared than any country in the world," to deal with the new global economic landscape, Lula added. "Brazil has been preparing for some time to become a solid economy."

Indeed, Brazil shows better signs of having bottomed than the U.S.―Since October 27, the iShares MSCI Brazil Index ETF (NYSE:EWZ) has gained over 8%, while the S&P 500 is down by nearly 2%.

That's a solid stock market reflection of the Brazilian consistency that more and more world leaders are latching onto.

As early as 2004, then-Secretary of State Colin Powell said that Brazil was a "serious candidate" for a permanent seat on the UN Security Council.

Now, French President Nicolas Sarkozy is using his final month in the European Union's rotating presidency to endorse Brazil as a UNSC fixture.

Sarkozy spoke unequivocally of his backing for the world's fifth most-populous country to open an EU-Brazil summit on December 22:

"We need Brazil as a permanent member of the Security Council," Sarkozy told the gathering.

Sarkozy also tethered EU financial policy to Brazil's, pledging to take a common policy approach to this coming April's G20 meeting of finance ministers and leaders of top global economies.

"We decided to narrow our positions and arrive in London with a common vision, on the future role of the IMF, the system of management of financial institutions," Sarkozy said.

Part of the French Prez's reason for cozying up to Lula has to be energy...

"Pro-Alcohol" and the Brazilian Energy Advantage

Brazil is the world's top producer of sugarcane ethanol, which is far more efficient than the corn-based variety most known in North America, and can be produced for only $1 per gallon.

Again, Brazil's advantage today stems from tough times in past decades―Brazil began its Pro-Alcohol program to create a nationwide fleet of flex-fuel cars in the 1970s. Shaky international oil markets and few strings to pull with producers meant Brazil had to figure out an alternative. Starting with crop science a generation ago, the tropical country's bountiful sugar resources now power cleaner vehicles driven by millions of newly prosperous citizens.

Sugarcane biofuel now contributes more than hydroelectricity to Brazil's energy mix, and the country's official National Energy Balance study for 2007 said that 46.4% of Brazil's energy that year came from renewable sources.

That's nearly 9 times the average clean energy contribution for the 30-country OECD, which is only 5.2%

So Lula is taking things a step further, lobbying Sarkozy and his European peers to make Brazil and other emerging countries top international suppliers of biofuel.

Bullish on Brazilian Biofuel Expansion

"We do not want European countries to dismantle their agricultural structure in order to plant sugarcane. We want them to invest in biofuel production in impoverished countries that have land available, such as the African countries," Lula told the International Conference on Biofuels in November.

Brazil is already engaged in the transfer of biofuel technology to African countries like Ghana.

And Lula has even brought the pressing issue of African migration to Europe into the discussion, couching Brazil's biofuel experience in a much larger international context.

"As long as there are impoverished nations, there are also going to be nomadic people seeking better opportunities," Lula contested.

Around 500,000 illegal immigrants enter the European Union yearly, according to official statistics.

Brazil can afford to be magnanimous and create biofuel Trans-Atlantic opportunities across the same latitude.

Though African countries may be empowered by Brazilian cooperation, it turns out that Brazil also has a potential fossil fuel bonanza just off its shores...

Petrobras Announced Major Finds in 2008

At the same conference where he offered a helping hand to Africa, Lula announced a 2 billion-barrel oil discovery. Brazil's U.S.-listed national oil company Petrobras (NYSE:PBR) is heavily active in biofuels, acting on the government's wishes over the years to make Brazilian cars and filling stations ethanol-friendly.

But at the end of the day, Petrobras is still Petroleo Brasileiro (Brazilian Petroleum). The company looks for oil all over Brazil, and it struck huge reserves at the deepwater Tupi and Carioca fields in 2008.

Now, those oil traps lay under miles of water and hard rock, and today's oil prices don't seem to justify new investment in offshore oil...

Yet we know that cratering oil prices create under-investment in the near term, which leads to lower supply and higher prices as the global economy starts to pull out of a recession. We hope for a U-shaped recovery to kick in before 2009 ends, but you can bet Petrobras will stick to its strategy.

Just as the government's commitment to the Pro-Alcohol biofuel program put Brazil in a position of power, Petrobras investors will reap the rewards of the company's long-term strategy.

Brazil's steady approach is bringing it to the center of international policy circles. That means more business for Brazilian enterprises and supercharged gains for investors who tap Brazil's new power.

Whither the Oil Markets

"Global Demand for Oil to Plummet," screams a recent Financial Times headline. Huh? No it won't. Who are they trying to kid?

Global oil demand is not going to "plummet." And for the FT to say so is just plain silly, if not irresponsible. OK, I know. There's an old saying that they teach in journalism schools. "You have to sell newspapers." But this declaration by the FT highlights the perils of letting a headline-writer do your thinking for you. It's what I call "arguing a screaming conclusion." And a wrong conclusion at that.

Oil Demand ― Down, Then Up

But let's move past the headlines. The Financial Times article explains that the World Bank has just issued a new study. The World Bank believes that the world is entering into the toughest economic times "since the Great Depression." Thus overall world oil demand may fall by about half a million barrels per day in 2009. That's what the World Bank states in its report.

Only half a million barrels? Heck, the total world demand for oil in the past year was about 87 million barrels per day (a fact that the FT article fails to note). By comparison, the Saudi oil tanker that was hijacked off the coast of Somalia held two million barrels of crude oil. And despite this act of piracy oil prices still fell over the next couple of weeks, even without that tanker plying its route across the deep blue seas.

So if the world experiences the next "Great Depression" (Release 2.0, I guess), a reduction in overall oil demand of half a million barrels per day is down in the statistical noise. And what the World Bank is saying about the grim future of the world economy is not the equivalent of "plummeting" demand. At least, not half a million barrels of lower usage.

How Bad Is It?

How bad is it out there? Well, according to this week's MasterCard Spending-Pulse data, U.S. retail gasoline demand is back to about the same levels it showed earlier in 2008. That is, high gas prices hurt demand over the summer and into the fall. (I drove less. Didn't you?) But the current low fuel prices have evidently allowed demand to recover. People are driving more. It's basic Economics 101.

I was talking with an economist for the American Petroleum Institute about two weeks ago. He told me that overall gasoline demand in October was down 3%, year-to-year. But diesel fuel usage was up by the same amount. Overall U.S. oil demand is down about 8%, but that reflects the slowing use of oil in industry. Out on the road, people are still driving and trucks are still hauling.

For all the sound and fury about the run-up in oil and fuel prices through July, and then the fall in prices after that, the aggregate demand for oil is only changing at the margins.

Built-In Oil Demand

In both the developed and developing worlds, there's a lot of oil demand built into the economic and social energy system. That's what modern development is all about. That's how the system was built over the past 100 years or so. Yes, you can wish that the system were different. You can even try to change the system ― and risk collapsing it in the process.

Whatever you do, you can't change the system very fast. To paraphrase a former Secretary of Defense, "You live in the world with the energy system you have. Not the energy system you might wish you had." 

So at best, if you want to change things you are looking at a generational shift. If you have a generation. Do we have a generation?

What Will OPEC Do?

Let's try looking at some different numbers. How about seven million barrels of oil per day? That's the amount of output that OPEC might have to shut-in if it wants to get prices headed back upwards in to the range of $75 per barrel or so. At least, that's according to Philip Verleger, a long-time industry player as quoted recently in Platt's industry newsletter The Barrel.

Current daily oil output from OPEC is about 32 million barrels per day. Verleger thinks that OPEC's output ought to be more like 25 million barrels per day. There's the seven million barrel shift. Easy, right? It would be as if Iran, Iraq and Qatar simply stopped exporting oil. How likely is that to happen? Umm…yes. Clearly, Verleger has a radical take on things.

One way or another, can OPEC cut production significantly? Does OPEC have the discipline to manage its own affairs to cut two million barrels, or four million, let alone seven million barrels per day? The issue is that numerous OPEC nations cheat on their production quotas. Hey, they need the money. Thus they lift the oil and sell it. Really, cheating on OPEC quotas is not a problem. It's a tradition.

What of the Future?

Looking ahead by more than about two years, world oil demand is certainly going to grow. It almost does not matter what we do in the U.S. or Europe. When you look at the numbers of young people who are already born and living and growing up in the developing world, the demand will be there. Many of these young people already have a cell phone and a laptop computer. When they finish school, they will want an apartment and a car.

And at the rate things are going, the energy industry is still under-investing in the necessary systems of the future. Depletion is still ongoing. It gets back to the very basic point that every barrel you lift from the ground leaves one less barrel down there. And the overall global depletion rate is 6% at best. Maybe it's 8%. It might be 10%. To replace that depletion, the general trend is for the energy industry to go further away, to deeper waters or more remote sites, to drill deeper wells, with hotter temperatures and higher pressures. Those little hydrocarbon molecules are just plain tough to catch.

And keep in mind that nobody can produce oil that has not been discovered. Or developed.  Or for which there are no handling facilities. That takes investment, and lots of it. Which requires money and finance, which is in rather short supply just now. So there are just a few years in which the world can reorder the way it does oil, let alone the big picture on energy. And there are a lot of moving parts in all of this.

The Moving Parts of Oil Production

One of our fellow (sister, actually) readers is deeply involved in monitoring the world oil situation. The other day she sent me a thoughtful list of "ifs" that have to happen just to begin to get future oil production on firm ground. Here it is:

• IF oil price rises above the marginal cost of new non-OPEC supply in time to get new production back on track;
     
• IF oil-producing countries and China stop subsidizing prices to their own populations;
     
• IF OPEC gives international oil companies (IOCs) like Exxon, Shell, Chevron, etc. access to explore and develop their reserves;
     
• IF the trillions in exploration and infrastructure capital are invested;
     
• IF OPEC invests seriously in increasing their own capacity;
      
• IF enhanced oil recovery (EOR) processes can really increase the recovery rate as much as hoped;
     
• IF the reported reserves are really there; 
      
• IF the U.S. Geological Survey predictions of "yet-to-find" oil in the Arctic, offshore and elsewhere are correct;
      
• IF the Saudis can are capable of reaching and sustaining 15 million barrels per day of output;

IF, IF, IF …

"And," adds my correspondent, "virtually all of these are outside the control of any policies that might be set by the oil-importing nations of the West."

So unless a lot of things happen ― pretty soon and in the right sequence, and competently ― we're going to be faced with the prospect that there's not going to be enough oil to go around. So oil prices are going to head back up. People and governments are going to get desperate over supplies. And much of the usual and predictable bad stuff that you've heard before is going to happen. Which gets back to that Financial Times headline. "Plummeting" demand? Really.

A Few More Dots to Connect

President-Elect Barack Obama made a major announcement last weekend. It was along the lines that his administration would work to invest in infrastructure. Congress loved it because it means that the politicians can appropriate money to spend on concrete and steel. That's what I've been saying would happen. But it's nice to hear it.

The announcement was good in the short term for a couple of the OI stocks, like Alcoa (AA: NYSE), Cemex (CX: NYSE) and General Electric (GE: NYSE). They all have things to sell into an infrastructure buildout, as do more recent additions like Koppers Holdings (KOP: NYSE) and Allegheny Technologies (ATI: NYSE).


Where will the U.S. government get the money to pay for the infrastructure buildout? Same place it gets all the money to bail out the banks and Wall Street, I guess. It'll borrow it. And in the process the U.S. borrowing will soak up most of the nation's "spare" capital, such as it is. U.S. government borrowing will crowd private borrowing.

The U.S. government can borrow money for the time being. For some strange reason, people still want to buy U.S. Treasury bills, bonds and notes. Don't ask me why. The interest rates are just about zero (safety sells, I suppose). And the dollar is strong. 

Actually, the dollar is much stronger than it ought to be. I expect a major dollar-correction in the first quarter of 2009, which will be good for foreign-denominated stocks that trade on the Toronto Exchange. (Although Canada is having some surprising political issues right now. I'd appreciate hearing from Canadian readers about their take on what's going on with Prime Minister Harper.)

In the longer run, the U.S. expenditures will come back as inflation. That means that you want to look at owning gold and shares in the best-run gold miners. If I had to pick just one gold miner with the best prospects, it would be Kinross Gold (KGC: NYSE). It's well managed. Kinross just completed a series of mine expansions. And it's ramping up production to sell increasing levels of output into a generally rising gold market.

Washington Mutual's Dirty Laundry

Here's another great story on the mortgage meltdown.

And while 2008 was certainly one we would all like to forget, it is important to remember the greed, fraud and stupidity that made it all possible. (In fact, I wrote about it this article over two years ago entitled: Housing's Ill-gotten Gains)

Because the truth is it all could have been stopped in 2005--but it wasn't. 

So the insanity of the housing bubble went on for years―long after it should have ended.

Unfortunately, all that is left now is the pain of its greed.

In the meantime here's another great look at how the train came so far off the tracks.

It's in a story on Washington Mutual that appeared over the weekend in the New York Times.

In case you missed it, it is well worth the read...

It's by Peter S. Goodman and Gretchen Morgenson entitled: At Washington Mutual, a relentless urge to approve any loan

"As a supervisor at a Washington Mutual mortgage processing center, John Parsons was accustomed to seeing baby sitters claiming salaries worthy of college presidents, and schoolteachers with incomes rivaling those of stockbrokers. He rarely questioned them. A real estate frenzy was under way and WaMu, as his bank was known, was all about saying yes.

Yet even by WaMu's relaxed standards, the mortgage on one home four years ago raised eyebrows. The borrower was claiming a six-figure income and an unusual profession: mariachi singer.

Parsons could not verify the singer's income, so he had the applicant photographed in front of the home, dressed in his mariachi outfit. The photo went into a WaMu file. Approved.

"I'd lie if I said every piece of documentation was properly signed and dated," said Parsons, speaking through wire-reinforced glass at a California prison near here, where he is serving 16 months for theft after his fourth arrest - all involving drugs.

While Parsons, whose incarceration is not related to his work for WaMu, oversaw a team screening mortgage applications, he was snorting methamphetamine daily, he said.

"In our world, it was tolerated," said Sherri Zaback, who worked for Parsons and recalls seeing drug paraphernalia on his desk. "Everybody said, 'He gets the job done."'

At WaMu, getting the job done meant lending money to nearly anyone who asked for it - the force behind the bank's meteoric rise and its precipitous collapse this year in the biggest bank failure in American history.

"It was the Wild West," said Steven Knobel, a founder of an appraisal company - Mitchell, Maxwell & Jackson - that did business with WaMu until 2007. "If you were alive, they would give you a loan. Actually, I think if you were dead, they would still give you a loan."

Speculation, fraud and greed....you can't have a bubble without them.