How many times do banana republics (and others) have to “nationalize” foreign investments before it seeps into the less avaricious portions of investors’ minds that perhaps it isn’t a good idea to start businesses, construct factories, build up the infrastructure, and hire and train locals while trusting generals in comic opera uniforms to abide by contracts and their pledged word? Okay, so Brazil’s top contender for Presidente is Dilma Rousseff, and elections are a scant two months away, but her gender and wardrobe aren’t as important as her ability to employ the politics of envy in order to play to her “something for nothing” crowd and please friends in high places.

The more I think about the timing, the more nervous about Brazil I get. What are those people thinking? Do most of the people in Brazil own land now? No. Were most of them in line to benefit directly from jobs with foreigners? No, but there was big money on the line for the top 5%. Was there a slight chance that small amounts of reals from enormous taxes and expenditures might filter down to those cheering now? A slight one. Does anyone care about the peasants? Only as voters and if they had any sense generals and juntas wouldn’t let the peons vote. Mexico has done quite well for decades with a variation on that theme. The ones with the most to gain, are those who already have the most, which is the way the world usually goes…which is what baffled me. Unless they think they can raise their own financing, why not hold off for a bigger pay-off?

What seems to me a bigger threat is the likelihood that politicos in Argentina, Belize, and Nicaragua might be inspired to go and do likewise, and some of us here in this very Bar have money on the line scattered around Latin America.

Brazil is an enormous country, rich in mineral deposits, with the potential to develop immense agricultural acreage at the optimal point in history when greatly increased populations are beginning to stagger into the late nineteenth century in terms of sufficient income to purchase more and more highly prized foodstuffs…which isn’t going to make the least bit of difference so long as the political structure in Brazil remains a combination of feudalism and socialism. One expert estimates that between 2006 and 2008 alone foreign investors dropped $2.5 Bn on land. That is certainly a nice chunk of money to confiscate by, um, repatriating the land, but the thought that anyone other than politicians and whatever the Brazilian equivalent of the haciendado class will benefit is risible. The rich will get richer, the poor will get poorer, and Brazil can sit there until the system changes…if it ever does.

Those enormous deep water oil deposits off the coast? Any country willing to confiscate foreigners’ cane fields won’t have any difficulty with the concept of nationalizing the rigs or 90% of the output, although I wouldn’t bet on Brazil’s ability to hire qualified personnel to keep the oil flowing afterwards. Brazil just turned off the money spigot and will learn that a big slice of pie is vastly superior to raw ingredients on the counter, no cook, and no oven. They will find out that “Brazilian land for Brazilians” means the status quo for most of the population and makes as much economic sense as doing their own dental work at home with nothing more than a rock. I don’t know what the average per capita income is in Brazil, but I doubt that it is much. Chuckle. I doubt that anyone is worrying about the peasants. (The things I do for you people! Wanting to know the precise term, I started Googling, and ended up on a terrorist site! For the record, amongst those who write in English the preferred term is “landless peasants,” not “peons,” or something quaint in Portugese.) To nobody’s surprise, half of all the arable land in Brazil belongs to 1% of the inhabitants, many of whom speak Deutsch.

Those who are not in the business have no conception of what it takes to turn scrub land into even pasture land, far less fertile fields. We spend a lot of time eying Potash here in the Bar, although it has certainly lost a lot of luster with me after the Brazilian ploy. From long experience, my surmise is that land currently being prepared for cultivation in Brazil will revert to scrub land in short order; I am quite certain that Brazil has vegetation similar to our smut grass, cacti, cedar, mesquite, broomweed, and others which engulf untended land in a very few years and return it to the wild within a decade or so. It is a constant battle to keep such pests at bay, and all of them devour nutrients and water. The mess over the sacred Cedar Waxwing in Central Texas placed a moratorium on cedar abatement programs for about a decade, and hundreds of thousands of acres are now covered thickly with cedar (which led to immense increases in allergic reactions) and mesquite. It turned out that Waxwings can live very happily many places and most of them migrated, I suppose because there isn’t nearly as much insect life left. Insects like crops and livestock, and there isn’t enough grass left to feed many cows and Boer goats.

Sure, beef is up and the demand is up, but range land requires fertilization, control of brush and weeds, and planting better quality grasses chosen to thrive in a specific climate. Crop land requires fertilization, control of brush and weeds, irrigation in many cases, erosion control following plowing, planting, cultivating, harvesting, and off-season maintenance. The last I heard the topsoil in the jungles which are being cleared is so thin that perhaps two crops can be grown before it reverts to wasteland. Land that is nourished and cared for needs to be planted in rotation and allowed to lie fallow on schedule. Unless the farmer puts as much back into it as he takes out, yields diminish rapidly — and then there are the Greens howling against pesticides, insecticides, herbicides, and artificial fertilizers.

The sub-equatorial climate of Brazil permits two crops a year. That may double the output, but it also doubles all of the ancillary costs other than land purchase. A diligent man can raise enough crops on an acre of land to feed a family…but I wouldn’t hunt for tenant farmers in the cardboard shacks crowding the cities. Perhaps 20% of the cane currently under cultivation is on land owned by foreigners, but can the indigenous personnel left continue operations? Ex-pat labor isn’t dumb, and the loss of income may well lead to increased anger against foreigners and/or an increase in activity of The Shining Path sort. One traditional solution is enslavement of the resident Indians.

Brazil will find it cannot go it alone. It simply does not have the know-how, the personnel, or the investment capital, and it doesn’t have my sympathy, either. “Brazilian land for Brazilians” now costs a great deal more, but the source of revenue dried up, and their rulers did it all by themselves.

I have little sympathy for Agribiz and they will get off quite lightly losing their investment at this stage — unless they know that there are always “exceptions” in dictatorships that create Blagojevich-type expenses, and doubtless they can hire a native front man. I rather think it is probably quite easy to work with Hugo Chavez if sufficient money changes hands under the table and on paper a firm is owned by Garcia, Rodriguez, Chavez, and Hernandez. Oh, sorry…that’s one of the loopholes Brazil just closed. I’m wondering again how those who made a hostile bid for Potash are feeling about now, because the premise was that Brazil would become the new bread basket of the world and require lots of it…

I’m glad that I passed up a rather attractive-appearing silver mining operation elsewhere in Souse America because between drug wars, the occasional coup d’etat, manana, and the chances of nationalization that didn’t sound like a good place to send my precious money even if the proffered rewards at present are quite appealing. I wouldn’t invest in a casino in Cuba, either, if an opportunity arose; any bunch that can run an excellent agrarian system into the ground isn’t my idea of a good candidate to provide a thriving industrial economy, although I admit cheerfully that no one in Cuba has nationalized American hotels and casinos in over fifty years, but only because Fidel and Raul have been in charge and don’t hold with Americans and their evil activities. Brazil didn’t even manage to attain a good agrarian economy.

Maybe I just need to get with the program…”American land for Americans!” We could nationalize everything that belongs to foreigners, particularly the Chinese, Japanese, and others holding large amounts of our debt, and proceed to “USA buildings for USA-uns.” Grab the cash, the inventory, and subsidiary holdings, and then take back the land given to Indians. Gee, maybe we could even repatriate all the land suitable for agriculture and oil leases the Feds have grabbed…”40 acres and a mule,” anyone?

Regards,
Linda Brady Traynham
Whiskey & Gunpowder

August 31, 2010

“Eet Eez Ze Costom of Ze Contry, Signore” was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Perhaps there is no better quote to illustrate the unique place of Russia in the investment world than this simple comment from the Financial Times: “Gazprom [the giant Russian oil and gas company] does not comprehend why its thinly veiled threats and bullying are not, as at home, seen as a normal negotiating tactic.”

What do we make of Russia? Assassinations, broken promises, corruption, frequent roughhouse tactics…these things loom large in the investor’s mind, reinforcing the idea of Russia as some sort of recurring nightmare. Then there are those flashbacks to 2004 and the whole Yukos fiasco. The government basically seized the company for back taxes in a move widely considered politically motivated (i.e., Putin didn’t like its ambitious billionaire CEO, Khodorkovsky, who was arrested and sent to rot in Siberia).

Investors lost everything — billions of dollars.

Russia seems to realize it has an image problem. I thought it was funny that various Russian news organizations/agencies published a lengthy advertising supplement recently in The Washington Post, called “Trendline Russia.” The six-page pullout section was like a mini-paper within the paper. The main point of which appears to be massaging the bruised reputation of Russia.

One headline grabbed my eye: “An Image of Future Russia: 80 Ireland-Like Regions.” And the cutaway quote: “Every Russian region, depending on its specific characteristics, can copy the breakthrough experience of Ireland or Dubai.” Heady stuff. These guys should be writing my marketing copy.

Russia’s bad reputation hasn’t yet soured investors. Even though they’ve gotten pie thrown in their faces before, investors keep coming. Foreign direct investment in Russia hit a record $27 billion through the first nine months of 2006. That’s a 43% increase from a year ago.

An Insider’s View From Moscow

Recently, I’ve been reading the comments and analysis of Eric Kraus, head of the Moscow-based Nikitsky Fund. On his fund’s site is an excellent free monthly newsletter, called Truth and Beauty (…and Russian Finance). I feel it is an insider’s on-the-ground account of what’s happening in Russia. As I love to get as close to the source as possible, Truth and Beauty has become a regular part of my reading. In his latest letter, Kraus takes to task what he calls “deeply biased Western pundits”:

“In 1997, you would have been warned of the impending collapse in oil prices, in 1998 of the catastrophic breakup of the Russian Federation — while every subsequent issue of The Economist has warned of a veritable potpourri of impending catastrophes…In the meantime, of course, oil prices quintupled, the Russian equity market has soared 30-fold, while Russian GDP has exploded to almost $1 trillion.”

Kraus points out that Russia’s growth rates over the last eight consecutive years make it the fastest growing economy in the Western Hemisphere.

Much of Russia’s success is tied to commodities, of which it is a veritable storehouse. Russia is the largest producer, or among the largest producers, of palladium, platinum, diamonds, nickel, and gold. Russia is also rich in oil and gas.

Russian oil giant Gazprom has a market capitalization of $250 billion, putting it in the weight class of international heavyweights such as Exxon and General Electric. The Russian stable also boasts other heavies such as Rosneft at $100 billion and Lukoil at $80 billion. These are just a few examples.

Russian multinationals are large and ambitious. They’ve raised billions on the London Stock Exchange. They’ve also spent billions buying up assets in emerging markets around the world — in Belarus, Ukraine, Kazakhstan, Uzbekistan, and Africa. But they are also active in more developed markets. In the U.S., for example, it was a Russian company that bought and turned around Rouge Industries, the fifth largest American steel producer and Ford supplier. It was a Russian company that paid $2.3 billion for Oregon
Steel Mills this past November.

So we see how the Russian bear is awake and has become quite the global competitor.

Russia and China — Getting Chummy

Russia’s economic wagon is lashed more and more to China and Asia. “Russia and China appear to be cozying up as never before,” The Wall Street Journal reports. In 2004, they resolved a long-standing border dispute, with Russia ceding some territory. In 2005, they carried out joint military exercises for the first time. China buys more than $1 billion worth of Russian weapons every year, making it Russia’s biggest customer. Trade between the two grew 37% in 2005.

And as China continues to scour the globe for resources, Russia figures prominently in those plans. Rosneft pledges to double its exports of oil to China and it will partner with CNOOC, the big Chinese oil company, to build an oil refinery and run gas stations in China.

Sparsely populated Russian territories bordering China are taking on waves of Chinese immigrants. By some estimates, there are over 250,000 Chinese living in Russia. This has also become something of a source of tension between the two, as small Russian towns fear becoming more and more Chinese and less and less Russian.

It’s fascinating to see all of this happen. An economically vibrant Russia certainly becomes something an investor must consider. I believe it is part of my role to analyze and report on events extraordinary and important, even though these insights may not lead to an immediate investment recommendation. I feel this is the case with Russia.

The Real Gems in Russia Are Hard to Get

As well as Russia has done, I don’t regret missing the explosive rally in Russian stocks. Surely, it is a tired and easy cliche, but investing in Russia still has the feel of playing Russian roulette. How do you account for the possibility of complete nationalization, as with Yukos? How do you account for the possibility of assets and contracts disappearing overnight?

I recently heard Bruce Berkowitz, the manager of the top-notch Fairholme Fund, speak at an investment conference. Though he may have been quoting someone else (I can’t remember), I scribbled on my notepad a quote that sticks in my mind when I think of Russia: “Anyone who accepts a small risk of losing everything will lose everything eventually.”

And then there is Douglas Adams, the great humorist. He had a great quote apropos of Vladimir Putin, Russia’s head of state: “When he heard the words ‘integrity’ and ‘moral rectitude,’ he reached for the dictionary, and when he heard the chink of ready money in large quantities, he reached for the rule book and threw it away.”

Kraus, though, is bullish on Russia. To his credit, he’s been right. But he invests in things that are hard for us to get at. “At Nikitsky,” Kraus writes, “we believe that the greatest value is to be found in privatized post-Soviet industrial assets — generally unpronounceable (e.g., Sevzapelektrosetskroy), hugely undervalued, and unknown outside a small circle of small-cap specialists.”

Short of investing in Kraus’ fund, there is no way for us to play in that sandbox. There are, however, a few backdoor plays. These are ideas that do not require an investment in a Russian company, but that benefit from some trend in Russia.

So in a world in which there seems to be many other possibilities, I see no reason to buy the popular big caps of Russia. I’ll keep watching.

Sincerely,
Chris Mayer

January 31, 2007

The Russian Bear Is Back was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.