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Investing in Chile Lithium

A New Play on Lithium

Written by Brian Hicks
Posted May 29, 2014

I have often described Chile as the star of Latin America — outshining heavyweights Brazil and Mexico in one category after another.

What’s to like about Chile?

The Heritage Foundation's Index of Economic Freedom ranks Chile as the most economically free country in South America. Chile is also noted for having the highest GDP per capita and the lowest corruption rates in Latin America.

Its debt-to-GDP ratio is only 6%, and it has already privatized its social security system!

The country has also been very smart and successful on social and market reforms, as Chile boasts a poverty rate of only 13%, down from 39% in 1990. During this same time period, per capita income has gone from $5,000 to $19,000.

Chile has a trade-to-GDP ratio that is the highest in the world, putting export powerhouse Germany to shame. Foreign investors are treated identically to domestic investors, and the country has the most modern transport network on the block.

The boom in commodity prices led to surging government revenues, but rather than spend, spend, spend, the surplus has been set aside in a rainy day fund that exceeds 10% of GDP.

This is all good stuff. But after reaching $80 in late 2011 and almost $70 in early 2013, the Chile iShares ETF (NYSE: ECH) has experienced a steady and painful slide, as you can see in this chart:

delfeld2

Pie Bakers vs. Pie Slicers

What went wrong?

First, 75% of Chile’s exports are raw materials, and copper alone provides one-third of government revenue, since the country is the world’s top producer and exporter. Tin, timber, fruit, and wine are just some of the other top exports.

Weakness in copper prices has certainly not helped the Chile ETF.

Second, Chilean politics seem to be unfortunately moving away from the pro-growth policies that have served its people so well over the last three decades.

When you think about it, there are really only two kinds of politicians: pie bakers and pie slicers. Pie bakers always focus on making the economic pie bigger for everyone through a pro-growth, pro-market agenda that leads to high economic growth. This means pursuing policies that treat capital well. Low tax rates on investment come at the top of the list.

On the other hand, pie slicers are obsessed with the distribution of income wealth even at the cost of making the economic pie smaller.

Unfortunately for Chile, the newly formed government of President Michelle Bachelet is decidedly made up of wrongheaded pie slicers. The tax measure it recently sent to its Congress is a recipe for low growth.

It raises the corporate tax rate from 20% to 35% and kills a key provision that has allowed companies to delay paying some taxes on earnings if they are reinvested.

This provision has played a key role in Chile’s rise, and eliminating it would be a major setback. After all, deploying earnings into new capital equipment, software, and infrastructure is the secret to the virtuous cycle of productivity and growth.

While opposition to these policies is growing, how can we take advantage of the pullback in the Chilean stock market?

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Driving from Copper to Lithium

Much of Chile's commodity future is squarely based around lithium and the country's largest global producer, Chemical & Mining Co. of Chile (NYSE: SQM) — even though only a small percentage of the company's overall revenue is derived from sales of this commodity.

The group has about a 30% global market share of lithium derivatives used for electric vehicle (EV) lithium-ion batteries. Currently, hybrid car batteries use nickel-metal hydride (NiMH), which are very heavy and not as efficient as lithium batteries.

The problem facing the battery industry is that it has yet to develop a way to mass-produce lithium batteries at the scale the automobile industry requires. Once this happens, global carmakers will shift to the lighter lithium batteries in order to boost vehicle (and SQM?) performance.

Finally, I can’t leave you without a play on Chile’s fine wines, thought by many to be the best in the world. Vina Concha y Toro S.A. (NYSE: VCO) is the country’s largest wine producer.

Now is the time to put a dash of value Chilean stocks in your portfolio.

Until next time,

Carl Delfeld for Wealth Daily

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