Global Perspective from the Investment Advisory Group Chile, Peru, and Copper at Crossroads
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Truist Advisory Services, Inc. from the Investment Advisory Group Global Perspective Chile, Peru, and copper at crossroads May 26, 2021 Summary In short order, voters in Peru and Chile will decide on the fate of their countries and very likely on the direction of global copper markets. In the longer run, due to heightened risk of resource nationalism, copper prices could move significantly higher. Chile and Peru account for nearly half of the world’s copper production, with a greater share of the world’s copper exports than Saudi Arabia has on oil exports. Copper prices increased over 25% in 2020 and have jumped another 28% in 2021. On the supply side, declining ore grades in older mines is an issue in already developed copper mines in Chile and the U.S. On the demand side, surging electric vehicles (EV) orders pushed the demand for copper dramatically higher. Eylem Senyuz Copper mine production by country – top ten countries in 2019 Senior Global Macro Strategist Chile (thousand metric tonnes) Portfolio & Market Strategy 6000 Peru China United Congo 2000 States Australia Zambia Russia Mexico Kazakhstan 1000 Data Source: Truist IAG, ICSG: The World Copper Factbook 2020. Not on scale. Past performance does not guarantee future results. Investment and insurance products: • Are not FDIC or any other government agency insured • Are not bank guaranteed • May lose value Chile: New constitution Background Chile’s social outburst of 2019—known as “Estallido Social”—turned into violent street protests crippling daily life in many cities. The social response to a benign rise in Santiago’s metro fare morphed into a major protest against income inequality, the rising cost of living, and corruption in the government. In October 2019, more than a million protestors marched on the streets of Santiago, Chile’s capital city, demanding President Sebastian Pinera’s resignation. The protesters argued current social injustices and inequalities were the result of the constitution written under military dictator Augusto Pinochet. Chile’s National Congress approved a referendum to draw up a new constitution to calm the protests. Independent and radical left candidates elected to rewrite the constitution Last week, Chile elected the constitutional assembly members responsible for rewriting the new constitution. The landslide victory of independent and far-left candidates of the assembly raised fears of a significant structural change in Chile. Two-thirds of the majority is needed for articles to be approved in the proposed constitution. Center-right candidates secured less than one-third of the assembly, preventing them from using veto power to block radical changes. In addition, the high number of independent assembly members would also make it harder to make predictions about the changes in the new constitution. A new constitution could not redistribute wealth but laws written in compliance with the new constitution could There is no doubt that a new constitution is a historic event in Chile. A new treaty to distribute the country’s vast wealth, especially copper, could mean significant structural changes. In many countries, a constitution is a body of basic principles that guarantee social rights, not a means to redistribute existing wealth among different groups. Laws written for and compliance with the new constitution would be able to redistribute wealth. To achieve that, a majority in Congress and an elected President who would approve those changes are needed. Historically, that is a more treacherous path than changing a universally hated constitution dictated during a military dictatorship four decades ago. Events in Chile could play out over several years, allowing cooler heads to finalize new rules and regulations that could improve the country’s future trajectory for laborers and investors. Peru: Presidential election Difficult choices for Peruvian electorate on June 6 Peru is about to choose its fifth President since 2018. The two candidates, Pedro Castillo and Keiko Fujimori are from both extremes on the left and right. For those outside Peru, Pedro Castillo is mostly an unknown candidate. A former schoolteacher and union leader, he was a key figure during the 2017 teacher strike in Peru. The opposition portrays him as a follower of the failed economic policies of Hugo Chaves of Venezuela or Fidel Castro of Cuba. Keiko Fujimori is the daughter of the former president Alberto Fujimori. Alberto Fujimori was a controversial figure with multiple human rights violations during his regime. He had to end his presidency early and lived in exile until his arrest and extradition. Keiko Fujimori’s candidacy represents her father’s legacy as she is using the same platform, which still has some support in the country. This is her third time running for the presidency. No matter who wins, Peru could be a country in political turmoil for a while No matter who is elected, a significant portion of the country could feel they were alienated in the coming years. Political turmoil coupled with a pandemic-induced economic recession took a toll on the Peruvian economy with the economy contracting 30% at the pandemic's peak— the worst result out of any significant emerging markets economy. Unfortunately, this presidential election appears unlikely to resolve Peru's chronic political struggles as both candidates are highly divisive. Pedro Castillo's presidency could make the country uninvestable for foreign investors for many years until guarantees of property rights are confirmed, depriving the nation of much-needed foreign capital during a copper price-led boom. Keiko Fujimori's presidency could ignite social unrest that could cripple the country's mines and production lines. With this much uncertainty, it's hard to imagine higher levels of copper production in Peru, the country's main export (27% of total exports). Investment implications for Chile, Peru and Copper The Argentinian peso, Turkish lira, and Mexican peso are guide posts for the Chilean peso and Peruvian sol In emerging markets countries, Argentina and Turkey are illustrative examples of uncertain political landscapes that make it difficult for foreign investors to invest. As a result, the currencies of these countries are close to 50% undervalued relative to their inflation-adjusted theoretical real effective exchange rate (REER), a measure of currency valuation. Even with a deep discount in value, only a few investors venture out to invest into these two countries. Mexico, with its hostile-to-business leader Andres Manuel Lopez Obrador (known as AMLO), is not as bad as Turkey or Argentina, but still, its currency is at 20% below its REER. Due to extreme political uncertainty, both Chilean and Peruvian currencies could move to discount levels in line with the Mexican peso. In Peru, the worst possible outcome would be if Pedro Castillo were to become President and nationalizes private assets. Similarly, in Chile, the worst result would be extreme limitations on private ownership rights of natural resources. In these worst-case scenarios, the Chilean peso could lose 50% of its value over time while the Peruvian sol could lose another 40%, which brings them on par with the Argentinian peso and Turkish lira. Real effective exchange rates (REER) 140 CLP PEN MXN ARS TRY 120 100 80 60 40 '15 '16 '17 '18 '19 '20 '21 Turkish lira & Argentinian peso at close to 50% discount Data Source: Truist IAG, Bloomberg Equities in Chile and Peru could revisit recent lows In the worst-case scenarios, Chile and Peru's most commonly-traded equities could revisit last year’s lows. Unfortunately, for foreign investors in Chile, the construction of a new constitution and the election of a new president are still in the distant future. The Presidential election is scheduled for November 21, 2021, and more importantly, the Chilean constitutional rewrite and corresponding referendum aren’t expected to be finished until sometime in mid-summer of 2022. Until then, negative headlines out of Chile could keep foreign direct investment or portfolio investments at bay. The Peruvian Presidential election is scheduled for June 6, and it could take a significant amount of time to figure out the true intentions and capabilities of Pedro Castillo if he wins. Similarly, if Keiko Fujimori wins, a brief period of relief could be displaced by social protests and unrest. For international investors, weakness in Chilean and Peruvian equities could coincide with strength in global copper prices. Political uncertainty could boost copper prices but simultaneously push equities and their currencies down. In this scenario, it would be better to have direct exposure to copper rather than via equities in these countries. Chile and Peru ETF prices 50 Chile Peru 40 30 20 Previous lows for Chile and Peru ETFs 10 '1/19 '4/19 '7/19 '10/19 '1/20 '4/20 '7/20 '10/20 '1/21 '4/21 Data Source: Truist IAG, Chile Equities = iShares MSCI Chile ETF (Ticker =ECH), Peru Equities = iShares MSCI Peru ETF (Ticker= EPU). International investments are subject to special risks, such as political unrest, economic instability, and currency fluctuations. Past performance does not guarantee future results. Copper: Inflation-adjusted price could reach all-time high levels Copper supply is constrained The world's copper producers are looking for greenfield projects as declining ore grades is an issue in the already-developed fields in Chile and the U.S. Increased energy costs, difficulty in finding water sources, and other cost-related issues have been major factors in driving higher production costs for copper. Developing new mines takes many years, and the ore grades of greenfields are lower than historical averages. In Chile and Peru, many companies may delay or outright cancel new mining operations until after the regulatory fog clears. According to industry experts, capacity for new mining operations is expected to grow at around 5% over the next five years.