Viva la Revolution!

May 9, 2006

Newly elected socialist/populist Bolivian President Evo Morales sent military troops to natural gas facilities on May 1st, claiming state control over the country’s resources. Oil companies were given 180 days to renegotiate contracts with the country – almost literally at gunpoint.

Such a move is bad for the global “oil imperialists” of the world like Exxon Mobil, Petrobras and Total S.A. It doesn’t bode well for investors in Latin American mutual funds like T. Rowe Price Latin America (PRLAX) – our current Latin American fund category favorite.

When socialism is on the march it’s best to get your money out of the way.

This is not the first time Latin America has flirted with nationalization. Latin American countries’ real socialist binge was in the late 1930s when Bolivia and Mexico confiscated Standard Oil’s operations. Exxon, one piece of the old Standard Oil monopoly (post U.S. government break up), has now been nationalized twice in the same country.

While most other countries have moved to privatize formerly state-owned businesses over the last decade, this bold nationalization is a rare step in the other direction – a move for more state control.

This backlash against capitalism seems to counter our own president’s assertions that “freedom is on the march” across the globe, with democracies sprouting up like daffodils in the spring – populist leaders, like the new Palestinian leader, were democratically elected. There are a few reasons why some countries are going backward (they would probably say forward) economically speaking.

The global commodity boom has enriched some questionable countries. Iran, Russia, and Venezuela top the list. If only our own trade balances and foreign reserves were as strong as these and other natural resource exporters.

The windfall profits created by the boom can support populist social programs that would ordinarily be unaffordable.

These massive profits are an attractive revenue source for governments. In our own wealthy and pro-business country there is now talk of creating windfall taxes on big oil. Imagine if the U.S. were poor and all the oil companies here were from other countries? Somebody in congress would probably move to nationalize the oil companies, too.

Russia has made moves to increase governmental control of the country’s natural resource companies – partially as a flagrant power grab, but also to undo past wrongs in a privatization campaign that left the citizens of the country out in the cold.

The perception of America as an unchecked empire is certainly higher today in many countries than five or ten years ago.

It doesn’t help that the departing head of Exxon had earned about a half billion – 5% of Bolivia’s entire GDP. Exxon’s revenues will triple Venezuela’s GDP this year, or amount to half of Mexico or Brazil’s GDP – the largest economies in Latin America.

Bolivia is one of the world’s poorest countries with 64% of the population below the poverty line. Only Haiti and Guatemala are lower in the western hemisphere – and unlike Bolivia, they aren’t sitting on a third of the natural gas reserves of Canada.

Such poverty makes the benefits of capitalism and foreign investment a tough sell, and the populist overtaking of business and resources for the people an easy one. This explains why these new people's heroes aren’t simply moving to raise taxes on foreign corporations (though they plan such a tax hike on the mining industry), which would likely do more for government coffers than heavy-handed nationalization. In fact, the newly elected Bolivian President ran on a platform promising such an overthrow.

Venezuela is South America’s biggest exporter of oil and the driving force behind the new Latin American socialism. President Hugo Chavez has been helping neighboring countries make similar moves. According the New York Times, “Venezuela agreed to supply Bolivia with 200,000 barrels of diesel a month at subsidized prices, donated $30 million for social programs and sent literacy volunteers into the Bolivian countryside.”

This could be the start of a Latin American OPEC-like structure with strict government controls and ownership of all natural resources, not just for oil, but metals, gas, and agriculture products as well.

Emerging markets have been hot in recent years – often the more resource-rich the country, the hotter the stock market. The Russian stock market is up over 1,000% over the last seven years.

Latin American funds are among the hottest. Our favorite, T. Rowe Price Latin America (PRLAX), is up 400% in less than four years. Back in 2002 we had an outperform rating (we rate fund categories for future potential in our favorite fund report) on the entire Latin American fund category and broader, emerging market funds. We have steadily lowered this rating along the way due to the inflows of money and massive performance. Now we are lowering this rating to our lowest outlook.

Kicking out foreign investors and nationalizing assets appears to be a growing movement. It won’t benefit investors. While emerging markets are still cheap compared to developed countries, they are supposed to be in order to offset this sort of political risk. You can be confident that France and Germany aren’t going to nationalize companies doing business within their borders anytime soon.