Spread Betting by Vince Stanzione

There have been suggestions that the emerging market of Brazil is overheating. While there are plenty of reasons to be bullish over the longer term, the current situation looks unattractive.

Regular readers will know that I was way ahead of the crowd when going bullish on Brazil in 2004 and then back again in 2009.

While this country has a lot going for it long term, in the shorter term (next six months or so) I see no reason to have any money in Brazil, and in fact it’s a great place to have a small short trade right now. This is the classic ‘day late and a dollar short’ scenario. Funds have flooded into Brazil in the past year and retail investors have bought into the ‘Brazil feeds China’ story, which has some truth. However, you always have to factor in how much of the news is priced in.

A victim of her own success? The Big Mac Index was developed by The Economist magazine, which, although not perfect, gives us a simple guide to price purchasing parity using a Big Mac burger.

Based on current prices, a Big Mac in Brazil is 47 per cent more expensive than one in the US, and while Norway and Switzerland are even more expensive, I don’t think you can compare Brazil to Norway. On the other end is China, where a Big Mac is 50 per cent cheaper than the US, which clearly shows how undervalued the renminbi is, even with all the talk of revaluing.

Consumer boom
The past year has seen a flood of new money into Brazil. With interest rates at near 12 per cent, if you can borrow money cheaply in US dollars then you have a nice carry trade. As many people are pulled out of poverty in Brazil, they are gaining a taste for what we take for granted, such as fridges, washing machines and cars, all bought on new-found credit.

The stronger Brazilian currency makes manufactured exports uncompetitive. Meanwhile, cheap Chinese imports, helped by an undervalued renminbi, are pouring into Brazil, hurting the domestic manufacturing sector.
Also, the prosperity is putting pressure on wage inflation, and many sectors are finding it harder to find workers. Office rents in major cities such as Rio are near, if not higher than, those in New York.

It’s a big headache for the new prime minister, Dilma Rousseff, who has inherited a booming economy from Luiz Inácio Lula da Silva, and it’s a fine balance to slow the economy down by turning new investment away without halting growth.

If we look at the iShares MSCI Brazil ETF (NYSE:EWZ), it’s been flat for the past two years. This ETF is fairly skewed by Petrobras (NYSE:PBR) which has an 18 per cent weighting, followed by mining giant Vale (NYSE:VALE),
on which I am currently short as I’m looking for lower industrial metal prices in the coming months.

The Market Vector Brazil Small Cap ETF (NYSE:BRF) has done far better and is up over 138 per cent since it was launched by Van Eck in May 2009. This ETF features companies that have more domestic exposure with a fair amount of exposure to the local property/construction market such as Gafisa SA (NYSE: GFA).

So far this year, BRF is down around 2 per cent and finding it hard to make any headway; in fact, many European markets such as Spain, France and Italy have made better returns. You can look to short Brazil by spread betting the EWZ or buying the Ultrashort Inverse ETF (BZQ). 

I am looking for at least a 10 per cent fall in the Brazil Bovespa Index between now and October, at which time we may start looking for some new buys.

Vince Stanzione has produced a home-study course to teach private investors how to benefit from trading financial spread bets and fixed odds. For more details visit www.fintrader.net