Chinese Commodity Demand Impact on LatAm
Over the past decade the fortunes of Latin America have become more closely tied to those of China. Latin America’s growth over this time period and the improving balance sheets in the region was closely tied to increasing commodity volumes and prices. Iron ore and copper have flowed out of Chile, Argentina and Brazil and supplied the world with raw materials, China accounting for the largest portion of increased demand.
Commodities account for 60% of Latin Americas exports and the rising prices of commodities over the past decade have played an important role. Higher prices contributed half of the growth in exports from the region, according to the OECD. Softening prices and an uncertain outlook for commodity prices in 2014 present some challenges for investing in the region, although the longer-term outlook remains positive.
Current Problems in China Adding to Uncertain Commodity Prices Outlook Bloomberg News reported on Thursday that the record import levels of iron ore and copper reported were largely the result of traders purchasing the raw materials to use as collateral. Stockpiles of iron ore at China’s ports are up 26% over the last twelve months. China’s credit reform initiative has left some companies needing credit but unable to obtain it. In order to secure lines of credit, these companies are importing iron ore and copper to use as collateral. These transactions have been in use for some time with an estimated 40% of imports brought in by trader as part of finance deals.
The problem now arising has emerged from declining demand and prices of iron ore and copper in China. Demand for steel is softening in China due to slowing growth rates and a decline in industrial production. Lower demand equals lower prices but in this case, it is causing problems for companies that have used it as collateral.
As the prices fall, holders of the secured debts require additional deposits to keep them whole. This is leading firms to sell the ore and copper at spot prices and creating additional downward pressure on prices.
Falling Commodity Prices could Trim Growth Outlook in LatAm
The falling prices and softening demand in China in turn is leading to slowing growth and investment in Latin America. The financial positions of governments and central banks can swing with commodity prices. Also, companies like Vale, BHP and Rio Tinto are throttling back capex on the softer outlook.
The biggest threat is that the real-estate and infrastructure build does not just slow in China, it grinds to a halt. If it is a bubble and it bursts the ramifications for Latin America are significant. While public debt to GDP ratios have fallen across the region, taking away some of the default risks the region became known for, it would still cause a significant impact to growth and investment in the region. On average, government debt levels average around 40% of GDP in the region compared to about 65% in 2002.
Long-term Trends Are Favorable
While there are headwinds in the near-term, long-term commodity demand should increase from a growing middle-class in China and the developing world along with significant needs for global infrastructure investment. Commodity exports can generate funds for Latin America for investment in their economies and growth over time.
The central banks in much of Latin America will have the funds to support growth. The availability of credit in the market should continue to increase, further fueling growth in the region.
However, it is important to note that there is some divergence expected. Central banks in Argentina and Venezuela in particular are facing pressure currently with reserve levels, causing concerns in the global markets and causing their currencies to devalue. However, much of Western Latin America is well positioned and have positive outlooks for 2014, Peru, Chile and Colombia among them.
Conclusion – Conditions in China are Important to Investing in Latin America
Latin American markets remain ripe for investment following the recent pullback in the markets. However, investors need to be more selective in which countries and industries they look towards. In addition, investing in the region requires a global understanding paired with regional knowledge. Commodity prices are very dependent on demand from China and their movement can shift at least the short-term outlook for many counties in the region.