Summary
- The Argentinean economy is stagnating and suffering from a host of problems, like high inflation, important market restrictions in international trade and energy and lack of access to foreign capital.
- However, many of these problems seem self-induced and could be resolved with a change of policies. An election later this year looks like the catalyst to change these policies.
- In the meantime, the Argentinean contrarian bet might still have some legs to run on.
Here is a land in the grip of a general strike, inflation above 30%, a stagnating or even shrinking economy, a debilitating exchange rate regime where importers and citizens alike have trouble getting hard currency (the so called 'cepo cambiario'), and it's technically in default. That land is Argentina.
Yet despite the above economic malaise, the stock exchange has been on a tear that is almost epic in proportions. The Merval, the most common Argentinean stock index surged almost 15% in March alone before giving back a bit.
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A significant part (at least 40%) of this spectacular rise since 2014 (or September 2013, to be more precise when there was a mid-term election in which the government lost pretty comprehensively) is just inflation, keep that in mind. This becomes clear when compared to the Argentinean ETF (NYSEARCA:ARGT), which has moved much less markedly.
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Some names, especially in the energy sector, have risen much more, for instance if we look at some companies that also trade abroad as ADRs, we can see Transportadora Gas del Sur (NYSE:TGS), Pampa (NYSE:PAM) and Edenor (NYSE:EDN) all with 30%+ gains in March, before giving back a bit.
How do we explain that? Well, part of it is that things have gotten so bad, many people think they can only improve. More especially after the November presidential elections, which are expected to be the end of the Kirchner area.
The President herself cannot run again and the economic problems, her abrasive style, and a high profile murder of Alberto Nisman, a prosecutor who accused her of entering into a deal with Iran to cover up the real perpetrators of a bombing of a Jewish community center in Buenos Aires in the 1990s.
While the case has now been thrown out by judges twice, the mystery surrounding the death of Nisman and the rather combative handling of the sensitive case by the President has cost her in terms of popularity.
Argentinian economic problems are, in essence, remarkably simple. Much of them can be traced to the huge energy subsidies that the government is doling out, to the tune of 5% of GDP, often to households which don't need them. These policies have numerous effects:
- They provided disincentives to investment in Argentina's energy sector and exploration by existing players, the result of this is that Argentina's energy balance has swung from a significant surplus into a significant deficit, which worsened the trade balance significantly
- It is a huge drain on public finances (to the tune of 5$ of GDP)
First, you see how the trade balance has worsened
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And here you see the public finances
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Instead of addressing the root problem and cutting, or even curtailing the energy subsidies, the Argentinean government chose to deal with the symptoms, which has made a manageable situation considerably worse:
- To cover the budget shortfall, the pension system was nationalized, the government uses central bank reserves to pay for foreign debt (which led to the central bank president Redrado resigning).
- Most damaging of all under these circumstances, the central bank embarked on printing pesos which led to inflation taking off, the government doctoring the inflation figures (which led to the IMF threatening to expel Argentina) and a loss of confidence in the peso.
- The resulting capital flight rapidly drained the foreign currency reserves of the central bank, which led the government to put severe restrictions on buying dollars (the traditional safe haven in Argentina) in the form of the 'cepo cambiario'
- Rather than remove the disincentives to explore Argentina's vast energy prospects, the government nationalized YPF. It remains to be seen whether they can muster the funds (tens of billions of dollars) required to develop the large Vaca Muerta shale oil and gas field, especially now that energy prices have fallen so much. The disincentives to invest in the electricity grid result in fairly frequent (albeit localized) power outings.
But as a matter of fact, if the root problem is fairly simple to identify, it's perhaps also fairly simple to address. That will have to be done by any incoming government, which is not due until the end of the year. The present government has all the hallmarks of abiding time, leaving unpopular measures for the next government to deal with in the hope regaining popular support.
One of these unpopular measures, greatly curtailing energy subsidies won't immediately solve Argentina's economic problems, but they're really imperative. But with lower energy prices, the impact of these is less, and there is some scope to give poor families some form of compensation through other programs.
And if there is a new government of a different political signature, there is almost bound to be a big devaluation and a fairly rapid dismantling of the exchange rate controls.
Indeed, one candidate (Buenos Aires mayor Mauricio Macri) has promised to do that his first day in office. But politics is unpredictable and there is a fair bit to go before the elections, a lot can happen between now and then.
Dismantling the energy subsidies and the exchange rate regime will go a long way to normalize the Argentinean economy, but it will be a bit of a shock therapy. Real interest rates will have to rise to make credit provision profitable.
Hopefully this will mostly come through a fall in inflation. If energy subsidies are greatly diminished, the public finances will be in better shape and the need to plug holes in public finances through money printing decreases. The latter is the motor under inflation.
With a change of government, there are several sectors well positioned to benefit, more especially the financial sector, real estate, and the energy sector. Let's start with the financial sector. Here are some financial stocks will rally, there are several to chose from with a US listing:
Real estate will also offer better returns, mortgage finance is extraordinarily low compared to other countries (as is bank lending in general), and the real estate sector has been stagnating for quite some time due to the scarcity of dollars (most transactions take place in cash in US$). Names here are:
We've already mentioned it, but the Argentinean energy sector contains significant promise. The Vaca Muerta shale field is one of the largest in the world. One could go with the well known names in the energy sector like:
Petrobras Argentina has done a lot better than it's parent Petrobras Brazil, embroiled in financial scandal and expensive deep sea exploration. George Soros is an investor in YPF and he recently doubled his position recently.
A smaller interesting Argentinean shale player is Madalena Energy (OTCPK:MDLNF), they are the only small independent company with a position in Vaca Muerta (and Agrio) besides YPF.
This is a company with a net 132,000 acre position in Vaca Muerta, apart from having other positions like the in the Agrio and Puesto Morales fields, and some 200 sectors in Western Canada (the Greater Paddle River). Last year, their proven (1P) reserves increased by 149% to 6490MMBoe, their 2P reserves increased 155% to 11494MMBoe.
These are conventional reserves based in Canada, from where they already produce some 5000 Boe/d (mostly oil). The company is debt free and has sufficient funds for the drilling program this year, but of course, like everywhere in the sector, the low prices aren't helping.
If you don't want the risks and complications of selecting individual companies you can simply stick with the Argentinean ETF, the Global X MSCI Argentina ETF . It's major holdings are:
- Tenaris S.A. , 20.62%
- MercadoLibre SA, 15.50%
- YPF SA , 6.94%
- Banco Macro SA , 5.34%
- Grupo Financiero Galicia SA , 5.14%
- Telecom Argentina SA , 4.39%
- BBVA Banco Frances SA, 4.17%
- Arcos Dorados Holdings, Inc., 3.65%
- Grupo Clarin SA, 2.61%
- Trans de Gas del Sur SA, 2.61%
- Other, 29.03%
Conclusion
The case for investing in Argentina amounts mostly to a bet on a regime change. Things are pretty bad today, but they are expected to get better with a change of government. The logic behind that seems strong, but you have to keep in mind that it is mostly a political bet, and politics happens to be rather fickle.
The case for investing in Argentina amounts mostly to a bet on a regime change. Things are pretty bad today, but they are expected to get better with a change of government. The logic behind that seems strong, but you have to keep in mind that it is mostly a political bet, and politics happens to be rather fickle.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
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