Brazil is no longer just a tourist hot spot, but a solid profit play for savvy investors, too. And one of the best ways to profit from Brazil’s expected 4.8% growth in gross domestic product this year is to invest in one of the Latin American nation’s infrastructure-focused firms.

Business has been good in Brazil, with the government and consumers alike enjoying the benefits. That means everyone has money to spend for improvements, whether it’s for the nation’s infrastructure or personal lifestyles.

Brazil’s government is planning huge investments to improve Brazil’s highways and byways. At the same time, a growing middle class is eager to snap up new automobiles and homes.

Certain Brazilian companies are well positioned to profit from the convergence of all of these spending trends. They supply the raw materials needed both to build new roads, as well as new dishwashers. And with such strong spending trends fueling growth, Brazilian firms that cater to both these needs are poised to reap the rewards.

Infrastructure Spending Spree

Merrill Lynch & Co. Inc. (MER) recently raised its annual infrastructure-spending estimate for emerging markets by 80%, as developing countries utilize large cash reserves generated by their fast-growing economies to bolster domestic development, BusinessWeek reported.

Investment in infrastructure will rise from $1.25 trillion to $2.25 trillion annually over the next three years, Merrill Lynch estimates. China, the Middle East, and Russia will account for 70% of infrastructure spending, but Brazil won’t be lagging far behind. 

The government’s program to facilitate infrastructure and construction investment, Programa de Acelere do Crescimento (PAC), was announced in January 2007 by Brazilian President Luiz Inacio Lula da Silva. The program is designed to provide government aid to complete construction projects more quickly and will focus on everything from upgrading oil, natural gas and electricity systems to expanding transportation and sanitation systems, as well as telecommunication networks throughout Brazil.

Through a combination of government funds and private investment, it is estimated that $235 billion (BRL500bn) of infrastructure development will occur during 2007-2010.

That’s a close match to Merrill’s own estimate of $225 billion in Brazilian infrastructure investments over the next three years.

And no one is in a better position to benefit from this huge influx of capital investment than Brazil’s own domestic resource companies. Without the huge shipping charges associated with buying steel from Asia or Australia, its only natural that contractors will turn to fellow Brazilian firms when it comes time to buy raw materials.

Consumption-Hungry Middle Class

While industrial and government capital investment is surging, consumer spending in Brazil is on the rise as the red-hot economy helps to expand the Latin American nation’s middle class.

In the past two years, more than 23 million people have leapt from Brazil’s lower income classes into the middle class, which is defined in Brazil by households with incomes between $450 and $745 a month. Brazil’s middle class now makes up almost half of the country’s population, according to Reuters.

And that expanding middle class is more than ready to spend some of its newly found disposable income on items such as automobiles, new homes, appliances and electronics. Household consumption rose 6.6% in the first quarter of this year, according to the nation’s statistics agency.

High inflation is taking a toll on consumers and a recent rate increase by Brazil’s central bank is expected to hurt consumer spending. But even with this expected slowdown, personal consumption growth is expected to increase 5.2% in 2009 according to economists at Itau Corretora de Valores SA.

A lot of those big-ticket items being purchased by the new middle class consumers are being assembled right there in Brazil, making Brazilian firms that supply raw materials such as steel and iron a smart bet for investors.

Four Brazilian Profit Plays

Here are a few of the firms set to profit from Brazil’s current trends:

• Companhia Siderurgica Nacional (ADR: SID) is a vertically integrated steel producer headquartered in Sao Paulo. CSN produces carbon steel and its products are a main raw material for several different manufacturing industries, including the automotive, home appliance, packaging, construction and steel processing industries. As an added benefit, CSN’s holdings include its own source of iron ore, as well as mines that provide all of the required limestone and dolomite, and a portion of the required tin for its steel-making processes.

“[CSN] is producing steel at the same time as raw material, so it is not exposed to price fluctuations,” Jack Dzierwa, co-manager of the U.S. Global MegaTrends fund (MEGAX), told MarketWatch. “It helps manage margins much better than if you were at the mercy of an outside supplier.”

CSN is up 4.12% year-to-date and the stock has traded in a range of $13.64 to $52.46 over the past twelve months. With a close of $31.08 yesterday (Monday), CSN is trading at a relatively affordable Price/Earnings ratio of 13.28, with a juicy yield of 6.26%.

• Formerly known as Companhia Vale do Rio Doce, Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. The world’s largest iron-ore producer with ancillary operations in gold, nickel, copper and other metals, Vale recently announced it would invest $5 billion to construct a power plant and steel mill in northern Brazil.

The project is a double boon to the mining company, as the steel mill represents Vale’s first solo-venture into vertical integration. And the 600-megawatt thermoelectric power plant will provide plenty of energy for Vale’s various operations in the region.

“This project is fundamental to guarantee energy to our projects, including to iron-ore, nickel, aluminum and copper operations,” Vale’s Institutional and Sustainability Director Walter Cover said in a telephone interview with Bloomberg News.

Vale closed at $24.81 yesterday and has traded from $13.64 to $52.46 over the past 52 weeks. The stock has been badly beaten down this year, but the new projects show great promise for reducing margins and creating a new revenue stream. Vale is trading at a forward P/E ratio of 11.95, with a yield of 0.94%.

• All these infrastructure projects and consumer manufacturing firms need fuel to keep them going and Brazil’s Petrobras (ADR: PBR) is just the one to supply it. This is one of the few emerging market oil companies with access to modern technology – and the willingness to work with the foreign oil majors. Petrobas is just coming off a record second quarter, with the highest earnings in the firm’s history.

Petrobras closed at $47.77 yesterday. Its shares are up more than 75% in the past 12 months, but the stock’s forward P/E still is only 9.20. The possible upside: Petrobas finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. Despite oil’s recent pullback, we’re ultimately looking for oil prices to rebound and head higher.

• Companhia de Saneamento Basico (ADR: SBS) is better known by its nickname, Sabesp. This Brazilian firm is the water and sewage system provider for the growing city of Sao Paulo. And with all of the new industrial and home construction currently underway in Brazil, Sabesp is definitely a growth business, and a virtual necessity. 

In June, Sabesp signed the Public – Private Partnership contract of the Alto Tietê System, which represents a $190 million (BRL310mn) project that will expand water treatment facilities in the Alto Tietê region and directly benefit 3.1 million people. Construction is slated to begin in approximately four months. It also recently received state approval to raise its tariff index to 5.10%.

Sabesp shares closed at $45.77 yesterday and have traded in a range of $37.07 to  $57.46 over the past 52 weeks. Its shares are down 2.62% year-to-date, but have a one-year return of 9.79%, and are currently carrying a forward P/E of 8.13.

News and Related Story Links:

• Money Morning:
  Is Brazil “Investment Grade” for Investor’s Money, Too?

• Money Morning:
  Merrill Lynch: Emerging Market Infrastructure Spending Will Surge 80% in the Next Three Years

• Money Morning:
  Two Big Reasons to Remain Bullish on Brazilian Stocks

• Bloomberg News:
  Vale to Spend $5 Billion on Steel, Power Plants in Para, Brazil

• MarketWatch:
  Build it on Rio

• Bloomberg News:
  Brazil Consumer Spending to Slow on Rates, Itau Says

Brazilian stocks as measured by the country’s Bovespa benchmark stock index has fallen 20% from its May 20 record, but that doesn’t mean it’s time to give up on Latin America’s largest economy. Brazil still has plenty to offer, and with stock valuations low, it’s a good time to go bargain hunting.

In fact, a big reason why Brazilian stocks have dropped is because the country’s central bank has been forced to raise rates to curb inflation. Policymakers have raised the benchmark rate twice since April, to 12.25%. Of course, inflation isn’t a problem unique to Brazil.

Inflation in India has been at alarmingly high levels since the first week of June, when it jumped from 8.75% to 11%. And many analysts expect government data released today (Friday) will show wholesale prices soared to a 13-year high of 11.75% in the week ended June 28.

China’s consumer price index (CPI), the nation’s primary gauge of inflation, increased 7.7% in May, after hitting a near 12-year high of 8.7% in February, and is expected to rise 7.2% year-over-year in 2008.

The European Central Bank raised its key interest rate a quarter point last week, after inflation hit a 16-year high of 4% last month, and U.S. Federal Reserve Chairman Ben S. Bernanke has also struck a more hawkish tone with regards to tightening monetary policy.

Brazil, said yesterday that its benchmark IPCA inflation rate rose 6.06% in the past 12 months, higher than the central bank’s 4.5% target, but still below the spiraling rates of China and India, and only marginally higher than inflation in the European Union.  Today’s inflation rate is also a marked improvement over the 12% Brazil clocked in 2002.

Also, unlike the United States and Europe, which are both grappling with sluggish growth as well as soaring inflation, the Brazilian economy is expected to expand by a bullish 4.8% this year.  And there are two big reasons why.

Brazil’s Booming Consumer Class

By 2030 an additional 2 billion people will have joined the global middle class, according to research by Goldman Sachs Group Inc. (GS). That’s a third of the world’s population and enough to cause a "shift in spending power towards middle-income economies." With its rapid growth and abundance of resources, Brazil figures to be a major focal point of that shift.

In the past two years, more than 23 million people have leapt from Brazil’s lower income classes into "Class C," which is defined by households with incomes between $450 and $745 a month. Class C, Brazil’s middle class, now makes up about 46% of the country’s population, according to Reuters.

The percentage of the population that makes up the lowest two classes, "Class D" and "Class E," dropped from 51% to 39% from 2005 to 2007.

This shift has caused a boom in consumerism throughout the region. Household consumption rose 6.6% in the first quarter of this year, according to the nation’s statistics agency.

While the majority of incomes have traditionally been spent on staples such as food, an increase in household wealth has resulted in a surge in spending on luxury goods. Sales of big-ticket items, like cars, homes appliances and electronics, have jumped 80% since 2005, according to Forbes.  Brazil has also become the fifth largest cosmetics consumer in the world.

Domestic demand has also been fueled by an increase in credit. The number of credit cards in Brazil rose 91% between 2002 and 2006, to 79 million, or one for every 2.3 people. And consumer loans, excluding credit cards, are expected to grow by 25% this year after soaring 40% in the first quarter, Erico Ferreira, president of the National Association of Credit, Financing, and Investment Institutions told Bloomberg News.

The surge in spending helped Brazil’s services industry, which accounts for about 60% of the economy, to grow 5% in the first quarter. Increased demand also boosted manufacturing by 6.9%, and agriculture, which now accounts for less than 10% of gross domestic product (GDP), grew 2.4%.

"Brazilians don’t get scared by 6% inflation," Ferreira told Bloomberg. "Companies want to profit from the growing economy and they know that to do so they need to offer longer maturities at lower rates."

Brazil Makes Some New Friends

Another big reason investors should keep believing in Brazil is that it has made some powerful new friends abroad.

Brazil’s resources are highly coveted by other emerging markets, particularly fellow BRIC country China, who is desperately seeking fuel for its own economic expansion. Brazil sent 6.7% of its goods to China last year, double the level of 2001.

Trade volume between China and Brazil totaled $29.7 billion in 2007, jumping 46.4% year-over-year, according to the latest statistics of China’s Ministry of Commerce.

Perhaps that’s why the Brazilian government has launched its "China Agenda" program, which involves a series of coordinated measures by the government and private sectors to triple Brazil’s exports to China and encourage more Chinese investment in Brazil.

According to Xinhua, Brazil wants to triple its exports to China from $10.75 billion in 2007 to $30 billion by 2010.

The Brazilian government has identified 619 products that are in high demand in China as priority export items to the country.  Meanwhile, the government has also proposed to include more manufactured products in its exports to China, 74% of which now are low-value commodities such as soybeans and pig iron.

Brazil has also sought out stronger ties with Middle Eastern powers. Most recently, plans were made to establish a permanent commercial center in the United Arab Emirates to promote investment between the regions. The U.A.E. is home to the Abu Dhabi
Investment Authority, or ADIA, a sovereign wealth fund with an estimated $875 billion in assets. Brazil is the world’s sixth-largest economy and home to an internal market of approximately 190 million consumers.

The new center will serve as a permanent exhibition of products from Brazil and Latin America, and tap developing investment and marketing opportunities between the regions.

It will also enhance Arab-Brazilian relations through the presence of future Gulf investments in Brazil, Ahmed Yassine, president of the Trade Exterior Chamber of Brazilian-Arabian Gulf and North Africa, told the Emirates News Agency. Yassine led a delegation of Brazilian businessmen on a tour of the region.
           
"An estimated 20 million people of Arab origin live in Latin America and 7 million of them are in Brazil," Yassine said.

In 2007, Gulf countries imported $4.6 billion in goods from Brazil, an increase of 4.8% from 2006.

Trade between Brazil and the Arab countries reached $9.4 billion in the first half of 2008 – 60.1% more than in the same period in 2007,
Gazeta Mercantil reported. June’s figures were also the highest ever for that month, with Brazilian exports totaling $966.15 million.

Profiting From Brazil’s Growth Spurt

With low valuations scaring off the fair-weather investors there are plenty of Brazilian stocks to profit from the country’s strong growth prospects. There are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40 to 50 more that are traded in the over-the-counter market. Here are a few attractive examples to consider:

• Banco Itau Holding Financeira SA, referred to usually as Banco Itau (ADR: ITU), has a forward P/E ratio of 12.94 and dividend yield of 0.45%.  Brazilian banks earn very high returns, primarily from domestic market lending in reals. Including Banco Itau, there are three large ones listed on the Big Board in New York; the other two are Banco Bradesco SA (ADR: BBD) and Uniao Bancos Brasile SA (Unibanco) (ADR: UBB). However, Itau is the cheapest of the three, though only slightly.

• Companhia Vale do Rio Doce, now referred to only as Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. An iron-ore company with ancillary operations in gold, nickel, copper and other metals, its shares trade at a reasonably valued at about 12 times forward earnings, though its dividend yield is only 0.74%.

• Petrobras (ADR: PBR) is one of the few emerging market oil companies with access to modern technology – and the willingness to work with the oil majors. Its shares are up 90% in the past year, but the stock’s forward P/E still is only 9.20. It has a 0.5% yield. The possible upside: It finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. If the world’s monetary authorities get serious about imposing higher interest rates to fight inflation, PBR and RIO would probably suffer as commodities prices fall back to earth.

• Companhia de Saneamento Basico (Sabesp) (ADR: SBS) is the water and sewage system provider for Sao Paulo. Now that’s a growth business, and not dependent on commodity prices. With a P/E of only 8.67 this is one stock I have to say I love.

• TNE (ADR: TNE) There are a bunch of Brazilian cell phone companies, but TNE appears to be the cheapest. It’s concentrated in the populous southeast and northeast regions of Brazil, with a forward P/E ratio of only 9.43 and yield of 2.17%. 

News and Related Story Links:

• Reuters:
  FACTBOX: Brazil’s new middle class

• Forbes:
  Spend, spend, spend

• Bloomberg:
  Brazil’s Economy Expanded 5.8% in the First Quarter

• Xinhua:
  Brazil seeks to triple exports to China by 2010

• Gazeta  Mercantil:
  FOREIGN TRADE: Brazilian-Arab trade breaks record in 1H

• Money Morning:
  Is Brazil "Investment Grade" for Investor’s Money, Too?

• Money Morning:
  Brazil Economy Expanded 5.8% in 1Q; Central Bank Likely to Raise Rates Again

• Money Morning:
  With its Move to the Top of an Index, Brazil Moves to the Head of the Class For Investors

With incomes rising all over Brazil, Banco Bradesco SA (ADR: BBD), the country’s largest private bank, plans to add 350 new offices throughout the country in the next year and a half.

In an interview with Bloomberg, Banco Bradesco Chief Executive Marcio Cypriano said the retail expansion is a bid to sustain the bank’s staggering 30% annual profit growth.

“It’s possible to maintain the profit growth as long as we can boost our client base,” Cypriano said. “We need to grow our network to reach these people that are earning more.”

As of now, the bank has 3,160 branches, 21% fewer than Brazil’s largest bank, state-owned Banco do Brasil SA, Bloomberg reported.

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Banco Bradesco’s mortgage lending nearly doubled between 2006 and 2007, from $1.32 billion (2.12 billion reals) to $2.5 billion (4.09 billion reals), and Cyriano said he expects $3.7 billion (6 billion reals) in mortgages this year.

Other income streams will be generated from expanding marketing efforts of its other business, such as insurance, brokerages and credit cards, Bloomberg reported.

Of course, each bank’s growth prospects wouldn’t be possible without Brazil’s overall economic performance and potential. Recently, the country posted a blistering 5.8% first quarter growth, its 18th consecutive quarterly gain and fastest rate of growth since 1995.

That doesn’t mean it will be easy for Banco Bradesco to keep profit growing at the same 30% pace it has been.

Walking the line between curbing inflation and promoting growth is tough for every emerging economy. Central banks often fight inflation by raising interest rates, but that pinches commercial banks because real estate is one of the first market that contracts in the face of steeper lending policy.

All things considered, Cypriano is optimistic.

“It’s difficult to say what’s the trend for return looking forward but I would say it’s more likely to remain stable,” he said.

Safe From U.S. Woes

Investors shouldn’t worry because, if anything, controlling growth is a good problem to have.

Secondly, Brazil is far enough removed from the sagging U.S. economy because South America as a whole has strong energy, mining, financial and agriculture industries, making them less reliant on U.S. imports.

Last year, Brazil’s main stock market index, Bovespa Holding SA, rose 71% – even faster than India’s.

And on Feb. 20, Brazil displaced China to become the world’s biggest emerging market, according to a key index – the Morgan Stanley Capital International Global Emerging Markets (MSCI GEM). 

That shift will likely attract billions in new money to Brazilian stocks, especially from money managers who benchmark their portfolios against the MSCI GEM index.

The bottom line: Expect money to flood Brazilian shares, says Keith Fitz-Gerald, Investment Director for Money Morning.

“Anytime a country moves to the top of that index there’s a strong re-indexing effect,” Fitz-Gerald said. “And that will lead to billions of dollars of institutional money being shifted as those professional investors rebalance their portfolios. They’re going to move substantial amounts of money into Brazilian stocks.”

News and Related Story Links:

• Bloomberg:
  Bradesco Bets on Retail to Assure Profit Growth Rises Above 30%

• Money Morning:
  Brazil Economy Expanded 5.8% in 1Q; Central Bank Likely to Raise Rates Again

• Money Morning:
  With its Move to the Top of an Index, Brazil Moves to the Head of the Class For Investors

Driven by heightened domestic spending, Brazil’s red-hot economy posted its fastest first-quarter growth since 1995.

The 5.8% economic expansion – the country’s 18th consecutive quarterly gain – fuels the notion that its central bank will continue raising interest rates to dampen inflation and demand.

“The figures show domestic demand is still strong,” Zeina Latif, an economist with Banco Real in Sao Paulo, told Bloomberg News. “The central bank will remain concerned with a mismatch between demand and supply.”

Since April, Brazil’s central bank has raised its benchmark rate, called the Selic rate, twice – from 11.25% to 12.25%. And economists are forecasting it could be raised as high as 14% at the bank’s next meeting.

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Food cost inflation in Latin America’s biggest economy had surged to 5.25% by mid-May, and well above the central bank’s generous target of 4.5%.

Walking the line between curbing inflation and promoting growth is tough for every emerging economy. In Brazil’s case, kicking up interest rates again will throw a wet towel on one of its hottest consumer markets – real estate.

“The economy is strong but we can’t say for sure it’ll continue this way if inflation eats into consumer incomes and credit begins pulling back,” Carlos Thadeu de Freitas Gomez, chief economist with Brazil’s National Confederation of Commerce, told Bloomberg.

Safe From U.S. Woes

Investors shouldn’t worry because, if anything, that’s a good problem to have.

Secondly, Brazil is far enough removed from the sagging U.S. economy because South America as a whole has strong energy, mining, financial and agriculture industries, making them less reliant on U.S. imports.

Last year, Brazil’s main stock market index, Bovespa Holding SA, rose 71% – even faster than India’s.

And on Feb. 20, Brazil displaced China to become the world’s biggest emerging market, according to a key index – Morgan Stanley Capital International Global Emerging Markets (MSCI GEM). 

That shift will likely attract billions in new money to Brazilian stocks, especially from money managers who benchmark their portfolios against the MSCI GEM index.

The bottom line: Expect money to flood Brazilian shares, says Keith Fitz-Gerald, Investment Director for Money Morning.

“Anytime a country moves to the top of that index there’s a strong re-indexing effect,” Fitz-Gerald said. “And that will lead to billions of dollars of institutional money being shifted as those professional investors rebalance their portfolios. They’re going to move substantial amounts of money into Brazilian stocks.”

Brazil Profit Plays

There are plenty of stocks to choose from. There are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40 to 50 more that are traded in the over-the-counter market. Here are a few attractive examples to consider:

• Banco Itau Holding Financeira SA, referred to usually as Banco Itau (ADR: ITU), has a Price/Earnings ratio of 12.20 and dividend yield of 2.4%.  Brazilian banks earn very high returns, primarily from domestic market lending in reals. Including Banco Itau, there are three large ones listed on the Big Board in New York; the other two are Banco Bradesco SA (ADR: BBD) and Uniao Bancos Brasile SA (Unibanco) (ADR: UBB). However, Itau is the cheapest of the three, though only slightly.

• Companhia Vale do Rio Doce, now referred to only as Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. An iron-ore company with ancillary operations in gold, nickel, copper and other metals, its shares trade at a reasonably valued about 13 times earnings, though its dividend yield is only 1.2%.

• Petrobras (ADR: PBR) is one of the few emerging market oil companies with access to modern technology – and the willingness to work with the oil majors. Its shares are up 168% in the past year, but the stock’s P/E still is only 19.37. It has a 1.3% yield. The possible upside: It finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. If the world’s monetary authorities get serious about imposing higher interest rates to fight inflation, PBR and RIO would probably suffer as commodities prices fall back to earth.

• Companhia de Saneamento Basico (Sabesp) (ADR: SBS) is the water and sewage system provider for Sao Paulo. Now that’s a growth business, and not dependent on commodity prices. With a P/E of only 8.33 and a yield of 2.7%, this is one stock I have to say I love.

• TNE (ADR: TNE) There are a bunch of Brazilian cell phone companies, but TNE appears to be the cheapest. It’s concentrated in the populous southeast and northeast regions of Brazil, with a P/E ratio of only 6.15 and yield of 4.25%.

• Telecomunicacoes de Sao Paulo SA, or Telesp (ADR: TSP) provides the fixed line telephone system for Sao Paulo. Before you sneer, consider this: the company has a dividend yield of 9.8% and a P/E ratio of 10.07 (which means the dividend is only just covered). And it’s majority owned by Spain’s Telefonica.

• Voturantim Cellulose (ADR: VCP) is a pulp and paper company, with a P/E ratio of 13.95 and a dividend yield of 2.8%. Trees grow fast in the tropics and VCP definitely benefits from that!

News and Related Story Links:

• Bloomberg:
  Brazil’s Economy Expanded 5.8% in the First Quarter

• Money Morning:
  With its Move to the Top of an Index, Brazil Moves to the Head of the Class For Investors

• Money Morning:
  Is Brazil “Investment Grade” for Investor’s Money, Too?

By Martin Hutchinson
Contributing Editor

Brazil is a lot like a person who gets a new job, pays off some of his debts, and has his credit score upgraded.

In pretty short order, all the charge-card companies boost his credit limits, cut the interest rates he’s paying on his outstanding balances, offer him new credit lines – and even make him eligible for various “rewards” programs that give him all sorts of freebies for spending money.

Brazil finds itself in that situation because uber-debt-rater Standard & Poor’s just boosted the country’s credit rating to “investment grade” in recent weeks, moving its rating from BB+ to BBB-. Why should we care? After all, isn’t Brazilian debt bought mostly by institutional investors? That’s true. But with the increased debt rating, Brazilian shares also should benefit – provided the government doesn’t embark on a big spending binge.

Brazil was included in the “BRIC” (Brazil, Russia, India, China) group of rapidly growing emerging economies that was created by Goldman Sachs Group Inc. (GS) back in 2003. At that time, it really didn’t deserve the distinction. Long-term growth since the 1970s had averaged less than 2% per capita, and the country had narrowly avoided bankruptcy only the year before. Long-term interest rates were above 20% (around 15% in real terms), which hardly encouraged companies to make capital-spending commitments that might grow the economy. Most alarming, a left wing socialist named Luis Inacio Lula da Silva had just been elected president.

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Brazil got lucky. First, Lula proved to be surprisingly moderate, not much to the left economically of previous Brazilian governments, perfectly willing to welcome foreign investment, generally friendly to the United States and not at all like his socialist neighbor, Venezuelan President Hugo Chavez. Second – and probably even more importantly – 2003 was the year in which energy and commodity prices began the long climb that has brought them to their current (astronomical) record levels. Third, since Brazil was not an oil exporter, there was no single source of new wealth that the government could just seize. Instead, revenue flowed to mining companies, the oil company Petroleo Brasileiro SA (usually referred to as just Petrobras) (ADR: PBR), and numerous agri-business operations that benefited from the rise in agricultural prices.

Most startlingly, Brazil’s ethanol program, which had been a hopeless boondoggle for a generation since it started during the oil crisis of 1979-82, suddenly became the envy of the world. Rising oil prices made Brazilian sugarcane the world’s cheapest and most economically and ecologically efficient source of newly fashionable ethanol. At a $20 per barrel oil price, the ethanol-from-sugar program was a typical example of misguided Third World government planning; at $120, it is a bonanza.

Brazil’s debt position has improved in three ways:

• The amount of outstanding debt has been reduced through modest repayments.
• Its ratio of debt to gross domestic product (GDP) has dropped sharply, as GDP in dollar terms has shot up with the revaluation of the Brazilian real against the dollar.
• And Brazil’s interest costs have dropped along with the country’s improving creditworthiness and with the generally low level of global interest rates.

With more income, a stronger currency and lower debt, it’s not surprising that Brazil’s credit rating has improved. As with an individual consumer on whom the credit card gods suddenly smile, what happens next depends on what use is made of the improved position. If a person reverts to their earlier spendthrift ways, they will quickly max out the new credit limits, actually making their position even worse than before.

Fortunately, the Brazilian government appears to have learned the difficult lessons of the last 25 years, and is remaining both careful in its spending and welcoming to foreign investment. That will bring down Brazil’s debt costs further, as will recent favorable developments like the discovery by Petrobras of about 36 billion barrels of oil in an offshore Brazilian oilfield.

Now, don’t get carried away. This isn’t China – with its 10% annual growth rate, apparently repeatable ad infinitum. Brazil had such growth rates for a brief period in the 1970s, but they disappeared around 1980 in a blizzard of unpaid debt. Brazil’s growth rate is currently around 5% – but it looks far more balanced and stable than it did in the 1970s. Brazil’s improving credit position is likely to make growth persist, and future political risk appears minimal. When Lula goes, a politician of the center-right could well replace him.

Another good sign for Brazil – there are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40-50 more that are traded in the over-the-counter market. Here are a few attractive examples to consider:

• Banco Itau Holding Financeira SA, referred to usually as Banco Itau (ADR: ITU), has a Price/Earnings ratio of 14 and dividend yield of 2.4%.  Brazilian banks earn very high returns, primarily from domestic market lending in reals. Including Banco Itau, there are three large ones listed on the Big Board in New York; the other two are Banco Bradesco SA (ADR: BBD) and Uniao Bancos Brasile SA (Unibanco) (ADR: UBB). However, Itau is the cheapest of the three, though only slightly.
  
• Companhia Vale do Rio Doce, now referred to only as Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. An iron-ore company with ancillary operations in gold, nickel, copper and other metals, its shares trade at a reasonably valued 13 times earnings, though its dividend yield is only 1.2%.
  

• Petrobras (ADR: PBR) is one of the few emerging market oil companies with access to modern technology – and the willingness to work with the oil majors. Its shares are up 168% in the past year, but the stock’s P/E still is only 16. It has a 1.3% yield. The possible upside: It finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. If the world’s monetary authorities get serious about imposing higher interest rates to fight inflation, PBR and RIO would probably suffer as commodities prices fall back to earth.
  
• Companhia de Saneamento Basico (Sabesp) (ADR: SBS) is the water and sewage system provider for Sao Paulo. Now that’s a growth business, and not dependent on commodity prices. With a P/E of only 9.2 and a yield of 2.7%, this is one stock I have to say I love.
  

• TNE (ADR: TNE) There are a bunch of Brazilian cell phone companies, but TNE appears to be the cheapest. It’s concentrated in the populous southeast and northeast regions of Brazil, with a P/E ratio of only 7 and yield of 4.25%.
  
• Telecomunicacoes de Sao Paulo SA, or Telesp (ADR: TSP) provides the fixed line telephone system for Sao Paulo. Before you sneer, consider this: the company has a dividend yield of 9.8% and a P/E ratio of 10 (which means the dividend is only just covered). And it’s majority owned by Spain’s Telefonica.
  

• Voturantim Cellulose (ADR: VCP) is a pulp and paper company, with a P/E ratio of 14 and a dividend yield of 2.8%. Trees grow fast in the tropics and VCP definitely benefits from that!

News and Related Story Links:

• Wikipedia: BRIC.
• Investopedia: American Depository Receipts.
• Wikipedia: Luiz Inácio Lula da Silva.
• Money Morning Financial Analysis: Venezuela Says “Adios” to Most Foreign Investment, Making it a Stay-Away Play for Investors.
• Wikipedia: Ethanol fuel in Brazil.
• Investopedia: 20 Attractive Investments: ADRs.
• Money Morning Economic Forecasting Series: Outlook 2008: The Latin American Economy is ‘Muy Caliente’.

After months of negotiations, Brazilian telecommunication titan Oi Participacoes (TNE) has reached an agreement to acquire rival Brasil Telecom (BRP), two newspapers reported Friday.

The reported $4.6 billion deal would consolidate a rapidly growing industry in the emerging South American economy, giving Oi – also called Tele Norte Leste Participacoes SA and already Brazil’s biggest phone carrier – a 70% share of Brazil’s fixed-line market.

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The newspapers reporting the deal – Folha de S. Paulo and Valor Economico – said the companies will announce more details next week.

The companies have been in talks since early this year. Brasil Telecom top shareholders, including Previ, Citigroup Inc. (C) and local pension funds, have said they are willing to sell.

Until the deal is official, investors can’t be too certain, as Brazilian law forbids one group from holding two separate telecommunications concessions. Although, the government is seeking ways around the law to permit the takeover, Reuters reports.

The World’s Biggest Emerging Market

Last year, Brazil’s main stock market index, Bovespa Holding SA, rose 71% – even faster than India’s.

And on Feb. 20, Brazil displaced China to become the world’s biggest emerging market, according to a key index – Morgan Stanley Capital International Global Emerging Markets (MSCI GEM). 

That shift will likely attract billions in new money to Brazilian stocks, especially from money managers who benchmark their portfolios against the MSCI GEM index.

The bottom line: Expect money to flood Brazilian shares, says Keith Fitz-Gerald, Investment Director for Money Morning.

"Anytime a country moves to the top of that index there’s a strong re-indexing effect," Fitz-Gerald said. "And that will lead to billions of dollars of institutional money being shifted as those professional investors rebalance their portfolios. They’re going to move substantial amounts of money into Brazilian stocks."

News and Related Story Links:

• Reuters:
  Brazil’s Oi finalizes Brasil Telecom deal -reports

• Money Morning:
  With its Move to the Top of an Index, Brazil Moves to the Head of the Class For Investors

Brazil has displaced China to become the world’s biggest emerging market, according to a key index – a shift that will likely attract billions in new month to Brazilian stocks.

Brazil overtook China as the biggest market atop the Morgan Stanley Capital International Global Emerging Markets (MSCI GEM) index on Feb. 20, rising to a weighting of 14.95%, compared to only 14.15% for China, the Financial Times reported. That move will likely have a huge impact on worldwide institutional money managers, since many professional investors benchmark their portfolios against the MSCI GEM index.

The bottom line: Expect money to flood Brazilian shares, says Keith Fitz-Gerald, Investmetnt Director for Money Morning.

"Anytime a country moves to the top of that index there’s a strong re-indexing effect," Fitz-Gerald said. "And that will lead to billions of dollars of institutional money being shifted as those professional investors rebalance their portfolios. They’re going to move substantial amounts of money into Brazilian stocks."

The MSCI index measures shares available to investors rather than the total market capitalization of all the companies traded on the exchanges in question. By that measure, China is three times the size of Brazil. The combined value of companies listed on the Shanghai and Shenzen exchanges was almost $3.9 trillion in January, compared with almost $1.3 trillion for the São Paulo stock exchange, or Bovespa.

With the U.S. economy wrestling with its worst housing downturn in decades, a massive credit crunch, an eviscerated greenback and even an outside chance for stagflation, this divergence is important for investors to note. An economic slowdown – or worse, a recession in the United States – was once the death knell for Latin American economies, which rely heavily on America as market for their exports. But the U.S. market seems to be loosing that grip as economies in Central and South America gather momentum from a global commodities boom and gain a more-diverse customer base for their goods.

Despite all the turmoil in the U.S. economy, the Latin American region has three of the four best-performing emerging-market currencies against the greenback. And one of those three – Brazil’s real – just hit an all-time high against the dollar.

Brazilian Stocks Sizzle

Last year Brazil’s main stock market index rose 71% – even faster than India’s – suggesting that international investors are awakening to the potential of the South American giant.

Since emerging market equities peaked at the end of October, Chinese share prices have fallen by 28%. Over the same period, Brazilian shares have gained 4.5%. The Standard & Poor’s 500 Index had declined about 7%.

The performance of the benchmark Bovespa has been so strong over the past month has been so strong that it has now erased the losses the index posted in January, Dow Jones reported. Those losses in the first month of the New Year were sparked by global uncertainty – especially those related to the ongoing worldwide credit crunch.

Part of the relative swing between Brazil and China shares was explained by a perception that Chinese shares were overvalued, Geoffrey Dennis, Latin American equity strategist at Citigroup Inc. (C) in New York, told The FT.

"Brazilian shares have been trading at 13 to 14 times earnings and Chinese ones at 30 to 40 times," Dennis said. "The frothy ones tend to do worse in a crisis."

Much of the investor interest was focused on Brazil’s two biggest stocks – Vale (RIO) and Petrobras S.A. (PZE). Vale is the world’s biggest exporter of iron ore; Petrobras has just made the world’s second-largest oil/gas discovery in 20 years, deep beneath the waters of the Atlantic Ocean.

But it’s renewable resources, not minerals, which are increasingly attracting investor interest.

The Commodity Boom Brings Wealth to Latin America

Investor sentiment has been especially favorable towards Latin American stocks – and Brazilian stocks specifically – because they believe that country and others in Latin America are better-protected from a global slowdown. Indeed, the global rush into commodities of almost every type has attracted a new group of trade partners to the shores of Latin America, and the resource-rich region has used the higher demand and higher resultant prices to amass war chests fat with cash reserves.

"Latin America has far better economic policies and tremendous support coming from high commodity prices," Jonathan Binder, who overseas $1.7 billion of emerging market assets at INTL Consilium LLC, told Bloomberg. "The region will be resistant to the kind of risk correlated to the U.S. [that] people previously expected."

Brazil is particularly fortunate to have strengths in both key commodity sectors – the so-called "soft commodities" created by the agricultural sector and "hard commodities" such as iron ore.

Jim Slater, the well-known British investor, says Brazil is "insulated against the world’s main shortages – fresh water, agricultural commodities and energy." And he should know: After making a fortune in the mining, base metals and minerals "super-cycle," Slater is now targeting agri-business as the next big global profit opportunity.

Brazil contains nearly one-fifth of the world’s fresh water, available to expand agricultural production and carbon-free electricity generation. Hydropower already provides 80% of the country’s electricity needs, and two big new dams are being built on the Amazon River at a cost of $10 billion.

Because Brazil is able to produce alcohol fuel from sugarcane, without subsidies, for prices competitive with petrol, the country has been dubbed "the Saudi-Arabia of ethanol."

"No country is better-positioned to benefit from the agricultural boom than Brazil, with its large and fertile land mass, absence of any desertification, and ample supply of fresh water," said David Fuller, a London-based analyst.

Brazil also is benefiting from an across-the-board rally in the prices of hard commodities.

Last week, the price of oil and gold continued their record-breaking runs. Spot gold rose as high as $964.70 an ounce and crude oil for April delivery climbed above $102 a barrel for the first time. Oil has averaged $93.02 a barrel this year, up nearly a third over the 2007 average of $72.30.

Meanwhile, silver rallied to its highest level since November 1980. Palladium jumped to a 6-1/2-year high, and platinum gained 1.7% – edging ever closer to its record of $2,206 an ounce. Platinum has gained more than 30% in the last month alone.

Since 2001, gold has risen 255% – from $271 per ounce to $961 on Feb. 27. Silver has gained 290%, and platinum has jumped 256%.
Iron and coal, two ingredients central to the production of steel, have also seen their prices soar.

On Feb. 22, Brazil’s Vale (RIO), announced that Chinese steelmaker Baosteel Group Corp., in negotiations on behalf of the Chinese steel industry, had accepted a price hike of 65% for iron ore. The move followed a Feb. 18 agreement between Vale and Japan’s Nippon Steel Corp. and Korea’s Posco (PKX), which also agreed to a 65% price increase.

Price negotiations for 2004 ended with an 18.62% increase, followed by a 71.5% rise in 2005 and a 19% increase in 2006. Vale, as the world’s biggest iron ore producer, typically sets the benchmark for contract negotiations. But this year BHP Billiton Ltd. (BHP) and Rio Tinto PLC (RTP) have said they will likely seek even higher prices for their ore. Together Vale, Rio Tinto and BHP control 80% of the iron ore market.

The spot price of iron ore has tripled in the past five years and is currently hovering around $200 a ton.

Coal, which is responsible for 78% of China’s energy output and 69% of India’s total energy supply, has soared to record highs as well. The price of coal is up 37% already this year, analysts say. And that’s after coal prices rocketed 73% in 2007.

GlobalCOAL’s monthly index for Newcastle thermal coal prices rose $1.71 per metric ton, or 1.9%, to reach $90.87 in January, the fourth consecutive monthly record.

Soaring commodity prices have helped countries like Peru, Venezuela, Argentina and Brazil generate trade surpluses with their Far East trading partner, bolstering their cash reserves.
But many analysts warn that the exposure to commodities is a risk. And Citi’s Dennis warned investors better not risk getting overly euphoric about Brazil’s prospects.

"It makes no sense with shares at this level to be complacent," Dennis said. "It’s inconceivable that you could have the U.S. economy in recession and a world economy that ignores that. Our concern is that commodities will start to correct."

Non-U.S. Exports on the Rise

One reason the U.S. downturn has yet to inflict any real pain in Brazil and its Latin American brethren is that those countries have broadened their lists of trading partners.

Trade between China and Latin America surpassed $100 billion last year, a benchmark the Chinese government didn’t expect to reach until 2010. Commerce between the two regions totaled $102.6 billion in 2007, a 46% increase from 2006, according to Chinese government data.

For purposes of comparison, consider this statistic: Last year, China’s trade totaled $302 billion in the United States and $73 billion with Africa.

Brazil sent 6.7% of its goods to China last year, double the amount in 2001. Chile, Peru, and Argentina exported to China twice what they imported from their Asian trade partner. Mexico exported $3.2 billion worth of goods to China last year.

The United States now absorbs less than 20% of the exports coming out of Brazil, Argentina, Chile and Peru.

The government of Brazil recently made plans to establish a permanent commercial center in the United Arab Emirates to promote investment between the regions.  The UAE is home to the Abu Dhabi Investment Authority, or ADIA, a sovereign wealth fund with an estimated $875 billion in assets. Brazil is the world’s sixth-largest economy and home to an internal market of approximately 190 million consumers.

The new center will serve as a permanent exhibition of products from Brazil and Latin America, and tap developing investment and marketing opportunities between the regions.

It will also enhance Arab-Brazilian relations through the presence of future Gulf investments in Brazil, Ahmed Yassine, president of the Trade Exterior Chamber of Brazilian-Arabian Gulf and North Africa, told the Emirates News Agency (WAM). Yassine led a delegation of Brazilian businessmen on a tour of the region.

"An estimated 20 million people of Arab origin live in Latin America and 7 million of them are in Brazil," Yassine said.

In 2007, Gulf countries imported $4.6 billion in goods from Brazil, an increase of 4.8% from 2006.

The amount of the region’s debt denominated in foreign currencies fell to 24.7% of gross domestic product in 2007, down from 44.1% in 2002, according to the International Monetary Fund.
In the 1990s some emerging markets ran out of foreign reserves and defaulted on debt. But trade surpluses brought about by soaring commodity prices have resulted in a bounty of foreign reserves for emerging markets.

Emerging markets have an estimated total of $4.1 trillion in central bank reserves The Journal reported. That includes a cushion of $185 billion in Brazil, $49 billion in Argentina, and $80 billion in Mexico.

Two Profit Plays to Make Now

Brazil does have some problems. Inflation is a major issue, and there’s always the worry that the bull market in commodities could taper off – at least for awhile.

But Money Morning’s Fitz-Gerald sees some strong investment opportunities. Two in particular stand above the others:

Banco Bradesco SA (BBD): With a market capitalization of nearly $63 billion, the Brazil’s second-largest bank markets banking, securities, credit-card and insurance services through its network of 3,008 branches. After soaring 28% last year, profits are expected to advance 25% this year and 15% in 2009.

According to Fitz-Gerald, "strong financial institutions are at the heart of any powerful economic surge. As Brazil continues to expand, Banco Bradesco can’t help but expand its profits" as it helps finance the economic growth in the country, as well as in the broader Latin American region. On Feb. 22, The Bear Stearns Cos. Inc (BSC) upgraded Banco Bradesco from "Peer Perform" to "Outperform," with analysts Saul Martinez and Matias Sacerdote writing in a report that Bradesco will benefit from improving profit prospects in its insurance and private-pension businesses.

What makes that upgrade noteworthy is the fact that the two analysts simultaneously downgraded Banco do Brasil SA – Brazil’s largest bank by market value – from "Outperform" to "Peer Perform."

Petroleo Brasilero SA (PBR): Latin America has an insatiable appetite for electricity. And right now, about 75% of the country’s power comes from hydroelectric facilities. That percentage will increase in 2012 when the region’s largest hydroelectric project, the Santo Antonio Dam, begins producing electricity. This is the first of three Amazon River however, Brazil’s state-controlled oil-and-gas dams the government hopes will decrease Brazil’s reliance on fossil fuels. Until then, Petroleo Brasilero - better known as Petrobras – will help meet demand. With a market cap of more than $257 billion, the Rio de Janeiro-based firm was a major factor in Brazil’s ascension to the top of the MSCI GEM index, Dow Jones reported. Dennis, the Citigroup analyst, and colleague Jason Press wrote that "the recent rise in Petrobras … has been key to the surge in Brazil’s overall weight."

One of the reasons that Fitz-Gerald likes both these companies – and Brazil in general – is that the country is doing more and more business with China, a market with tremendous long-term prospects.

The same holds for Brazil, Fitz-Gerald says.

"Brazil has tied its fortunes to China, and has a bunch of companies that do business with China," he says. "And in the long-term, that holds out the potential of being an exceptional value."

Money Morning Editors Jason Simpkins and Mike Caggeso contributed to this report.

News and Related Story Links:

• The Financial Times:
  Brazil Moves to Top of Emerging Market Index.

• Money Morning Economic Analysis:
  Economic Carnival Cruises on in Latin America, Despite Sinking U.S. Market.

• Money Morning Economic Analysis:
  How and Why Investors Should Tap Resource-Rich Brazil.

• CNNMoney.com:
  Brazilian Bank Taps Emerging Market Growth.

• Bloomberg News:
  Bradesco Raised, Banco do Brasil Downgraded at Bear Stearns.

• Dow Jones News Service:
  Emerging Markets Report: Brazil Becomes World’s Biggest Emerging Market.

Several years ago, investment bank Goldman Sachs Group Inc. (GS) devised the new idea that four big countries – Brazil, Russia, India and China – would together soon become so important to the global economy that they could be viewed as a single, cohesive market – much as we think of Europe or Latin America as being a single economic entity.

Goldman Sach’s marketing minds dubbed the member countries as “The BRICS” [pronounced “bricks”], an acronym comprised of the first letters of each country’s name. And the investment-banking giant boldly predicted that this economic bloc would grow in both importance and magnitude. Now just 15% the size of the world’s six most advanced economies [including the United States and Japan], Goldman predicted that the BRICS would grow to become even larger than the six leaders in no fewer than four decades.

The obvious conclusion was that long-term investors should focus on the BRICs. And Goldman’s logic was sound.

Global Demand

“Chindia” is developing a gargantuan appetite for the natural resources – energy, metals and foodstuffs – that it needs from the rest of the world.

Brazil and Russia, by contrast, are among the handful of countries best situated to supply those increasingly valuable natural resources [For a related article on Russia’s global growth aspirations in today’s issue of Money Morning, please click here].
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Russia is a huge exporter of oil and natural gas, nickel and platinum-group metals. Brazil is the world’s biggest supplier of such internationally-traded agricultural products as sugar, soybeans, coffee, corn, orange juice, beef and poultry.

Both still have enormous resources that can be developed to meet Asia’s growing demands.

And neither faces shortages of energy, food or water.

The Case For Brazil

Last year Brazil’s main stock market index rose 71% – even faster than India’s – suggesting that international investors are awakening to the potential of the South American giant.

Much of that interest was focused on Brazil’s two biggest stocks – Vale (RIO) and Petrobras S.A. (PZE). Vale is the world’s biggest exporter of iron ore; Petrobras has just made the world’s second-largest oil/gas discovery in 20 years, deep beneath the waters fo the Atlantic Ocean.

But it’s renewable resources, not minerals, that are increasingly attracting investor interest.

Brazil has two things much of the rest of the world is lacking – a plentiful supply of fertile land and a huge amount of fresh water, thanks largely to the Amazon basin. These factors have combined to make Brazil the world’s largest supplier of a huge range of soft commodities – from sugar and coffee, to beef and chicken

Jim Slater, the well-known British investor, says Brazil is “insulated against the world’s main shortages – fresh water, agricultural commodities and energy.” And he should know: After making a fortune in the mining, base metals and minerals “super-cycle,” Slater is now targeting agri-business as the next big global profit opportunity.

Brazil contains nearly one-fifth of the world’s fresh water, available to expand agricultural production and carbon-free electricity generation. Hydropower already provides 80% of the country’s electricity needs, and two big new dams are being built on the Amazon River at a cost of $10 billion.

Because Brazil is able to produce alcohol fuel from sugarcane, without subsidies, for prices competitive with petrol, the country has been dubbed “the Saudi-Arabia of ethanol.”

“No country is better-positioned to benefit from the agricultural boom than Brazil, with its large and fertile land mass, absence of any desertification, and ample supply of fresh water,” said David Fuller, a London-based analyst.

Other commentators point to the nation’s economic growth rate [around 5% a year], a foreign trade surplus [running at about $40 billion a year], large foreign reserves, a strong currency and a buoyant stock market as key points of attraction for potential investors.

Last year Brazil attracted $37 billion in foreign direct investment in factories and business operations – twice as much as India. It ranked third in the world in terms of the amount of investment capital raised via equity issues, outpaced only by the United States and China. And its international bonds are expected to be granted investment-grade status within two years.

Brazil has a flourishing middle class of 20 million – as much as five times bigger than India’s … depending how you define “middle class” – as well as political stability, a favorable environment for foreign investment, and an economy that’s a strong jobs-creation machine [5 million new jobs since 2000].

The favorable international-business environment of the past few years – combined with sound government policies, disciplined finances and liberalized trade rules – has delivered low inflation and a general decline in market interest rates.

One result is the emergence from poverty of a new lower-middle class, so the nation’s notorious income inequality has been declining.

What are the negatives?

Despite the gains the government has made, problems remain. The public sector is bloated and corrupt, packed with jobs-for-life bureaucrats who have fat pensions to dream about upon retirement.

The taxes that underwrite this waste gobble up about a third of the national output – a proportion much higher than in other emerging markets and out of proportion to the low quality of services provided.

Brazil  also has some serious infrastructure problems, including power-supply shortages. The regulatory environment is not sufficiently clear to attract private investment.

Labor laws are highly restrictive, with welfare and other compulsory contributions adding 60% to 100% to employers’ payrolls.

The stock market is very sensitive to flows of foreign capital, therefore exposed to adverse money shifts that may be triggered by developments unconnected with conditions in Brazil itself, such as the U.S. subprime crisis.

Finally, remember that although Goldman Sachs Group’s BRIC study projected good per capita growth rates for the Brazilian economy over the coming decades, it suggested the three other nations in the group would grow even faster.

How to Invest in Brazil’s Strengths

Just as China is the dominant economy in Asia, Brazil is the dominating force in South America. But that doesn’t mean it’s alone, nor does it mean the country is the sole source/beneficiary of the continient’s economic growth. 

So investors who want to invest in Brazil should equally consider investing in South America as a whole.

As with any investment, research is necessary to sidestep potential pitfalls. Money Morning Contributing Editor Horacio R. Marquez, an emerging-markets specialist and Argentine native, highlighted three catalysts of Latin America’s economic growth:

1. The price of commodities/global growth: Continued growth in China, India and other emerging markets can only further stoke the already-high demand for commodities. For example, China’s consumption of iron ore is one of the top reasons why the share price of Vale more than doubled last year.

2. The "second wave" of profits: This refers to the countries’ ability to keep driving their economies by increasing the size of their own consumer markets, and then building demand among those consumers.

3. The health of the U.S. economy: If anything tugs at South America’s growth, it’s the region’s economic ties with its trading partners, especially the United States. It wasn’t a coincidence that when the U.S. greenback declined last year, the Brazilian real dropped in virtual lockstep. A wild card here is how the subprime fallout plays out in Europe, another key sales destination for South American exports. 

Investors can dodge this potential trap by avoiding currency trades, and eschewing the shares of Latin American companies whose primary customer is the United States.
Instead, investors should focus on Latin America’s wealth of commodities [which are in demand in nearly every world market], and companies that profit from the region’s growing middle class.
Here’s a breakdown of the continent’s strongest sectors, as well as their potential profit plays:

• Energy: Latin America’s appetite for energy is nothing short of ravenous. As of now, three-fourths of the country’s electricity comes from hydroelectric power. That figure will be higher in 2012, when the region’s largest hydroelectric project, the Santo Antonio Dam, will begin producing electricity. Santo Antonio is the first of three Amazon River dams the government hopes will decrease Brazil’s need for fossil fuels. Until then, however, Brazil’s state-controlled oil-and-gas company, Petroleo Brasilero SA (PBR) will continue to meet the demand.

• Food/Retail: As South America’s population and middle class expand inland from its coastal metropolises, the food and retail sectors are some of the first to profit. One company that’s been profiting from this population-and-development trend is the Companhia de Bebidas das Americas, also known as AmBev (ABV), a $45 billion Brazil-based beverage powerhouse that produces, sells and distributes beer, draft beer, malt, soft drinks, sport drinks, iced tea and water throughout Latin American and the Caribbean. Similar, though smaller, the Companhia Brasileira De Distribuicao (CBD) is a food retailer with more than 550 supermarkets, home appliance stores and convenience stores throughout Brazil.

• Mining: South America is stuffed with metals. And with commodity prices soaring, this is a good market to be in. As mentioned earlier, Vale is making a killing feeding China’s appetite for iron ore. It’s the second-largest mining company in the world, and the largest producer of iron ore and nickel. The Phoenix, Ariz.-based mining giant Southern Copper Corp. (PCU) heavily taps South America’s rich copper mines. Though based in the United States, this company has all of its mining, refining and smelting operations in Mexico and Peru. With this stock, however, investors are subject to the volatility of the U.S. market, which doesn’t look very promising in the first half of the year.

• Banking/Real Estate: According to Money Morning’s Marquez, "when the [Brazilian] economy expands, [banks] do fantastically well." And the same goes for real estate. Some of the first banks to profit from the growth of the middle class are Banco Bradesco SA (BBD), Uniao de Bancos Brasileiros SA (UBB) – also known as Unibanco – and Banco Itau Holding Financeira SA (ITU). "Buy them and go to sleep," Money Morning’s Marquez said.  But white-knuckle speculators may want to roll the dice on Gafisa SA (GFA), a homebuilder based in Sao Paulo, Brazil.

• ETFs: Investors who are wary of investing directly in foreign companies have a few exchange-traded funds to choose from. The iShares Standard & Poor’s Latin America 40 Index (ILF), which tracks highly liquid securities in Mexico, Brazil, Argentina and Chile, ended 2007 with a 44% gain. There’s also iShares MSCI Brazil Index Fund (EWZ), a capitalization-weighted index that aims to capture 85% of the total market capitalization in Brazil. It invests in a sample of securities and is reviewed quarterly. Last year, it gained a healthy 72%.

News and Related Story Links: 

• United Nations Economic Commission for Latin American and the Caribbean:
  Preliminary Overview of the Economies of Latin America and the Caribbean 2007

• Money Morning:
  Brazil’s Petrobras Agrees to Invest up to $1 Billion in Bolivian Natural Gas Projects

• Money Morning:
  Outlook 2008: The Latin American Economy is ‘Muy Caliente’ 

• Money Morning:
  Brazil’s Petrobras Agrees to Invest up to $1 Billion in Bolivian Natural Gas Projects.

• Incademy.com:
  Ten Great Investors: Jim Slater.

•  MineWeb International:
  Jim Slater moves from metals to agriculture as favoured investment sector.

• Wikipedia:
  The Economy of Brazil

• Money Morning Special Investment Report:
  Nine Ways to Profit From the Diving Dollar

• Wikipedia:
  The Brazilian Real

Bolivia’s state-run oil company, YPF Bolivianos, will get up to a $1 billion investment for local natural-gas projects from Brazil’s state-run oil company, Petroleo Brazileiro SA (PBR), also called Petrobras.

The deal – signed by the presidents of both South American countries – calls for $750 million to $1 billion to be invested in YPF. The varying dollar amount is dependant on the results of new exploration. Bolivia has the second-largest natural-gas reserves in South America, after Venezuela home of the largest. 

The deal makes Petrobras the first company to announce investments in Bolivia since Bolivian President Evo Morales nationalized refineries and much of the oil-and-gas infrastructure in May 2006.

Morales’ move initially caused tensions between the two countries, because Petrobras previously controlled a 14% stake in Bolivia’s gas reserves. But the countries’ presidents both expressed confidence in the deal.

"Tensions will not affect our intention to maintain a permanent dialogue, to cooperate and to help Bolivia," Brazil President Luiz Inacio Lula da Silva told the Bolivian newspaper, La Razon, according to Dow Jones. "My visit here is clear proof of what I am saying."

The diplomacy may seem a bit forced, but Brazil’s surging economy and its growing demand for energy is forcing the country to seek out new supply partners. Such high demand takes away some of Brazil’s bargaining power, despite being the continent’s largest country and the ninth-largest economy in the world.

Think of it this way: If you were the Brazilian president trying to keep pace with your country’s ravenous energy consumption, would you rather buy natural gas from neighboring Bolivia or negotiate with Hugo Chavez in Venezuela? 

News and Related Story Links:

• Dow Jones:
  Brazil To Resume Investments In Bolivia – Report

• Bloomberg:
  Petrobras to Invest Up to $1 Billion in Bolivian Gas

• Wikipedia:
  Luiz Inácio Lula da Silva

• Wikipedia:
  Evo Morales

• Money Morning:
  Nine Ways to Profit From the Diving Dollar

• Money Morning:
  Venezuela Says "Adios" to Most Foreign Investment, Making it a Stay-Away Play for Investors

Banco do Brasil, Latin America’s largest bank, said profits rose 50% in the third quarter, due to borrowers taking advantage of record low interest rates.

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Farmers comprise a large portion of the government-controlled bank’s borrowers. High crop prices – particularly sugar cane for ethanol production – gave farmers more financial leverage to borrow more to expand their operations, Bloomberg reported.

"Banco do Brasil has the best position to capture all the activity generated by such a positive environment in the agribusiness," Regis Abreu, who helps manage $1.08 billion (1.9 billion Brazilian Reais) in assets at Mercatto Gestao de Recursos in Rio de Janeiro, told Bloomberg. "It’s the bank that has a long-time relationship with farmers who are making a lot of money now."

Down the road, Banco do Brasil may reap massive profits from its growing credit portfolio, which expanded 27% this quarter. Brazil and its surrounding countries are  promising emerging consumer markets where an increasing number of people will finance large-scale items such as cars and houses and sign up for credit cards for the first time.

News and Related Story Links:

• Bloomberg:
  Banco do Brasil’s Profit Rises 50 Percent on Lending

• Money Morning:
  Brazil Aims for 5% Annual Growth

• Money Morning:
  Agri-Biotech Monsanto Buys Brazilian Corn-Seed Company