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Malcolm Shaw
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A retired sell-side analyst and hedge fund VP focussing on companies where technical understanding matters. With a MSc in Geology and 12 years of experience spanning the resource and investment industries, my focus is on companies where digesting data and looking at underfollowed companies can... More
  • Argentina And The Peso Devaluation -- Does It Even Matter? 2 comments
    Jan 23, 2014 5:46 PM | about stocks: CWVLF, MDLNF, APEOF, APAGF

    A quick note after many discussions today regarding press reports and currency moves surrounding the Argentinean peso. Any Google search of "Argentina peso" will yield commentary on the topic. In brief, the Argentinean central bank at least temporarily stopped artificially supporting the Argentinean peso, which has resulted in a sharp devaluation of the currency. To me, the numbers aren't overly important, but the overarching details are...

    First things first. For years, the Argentine central bank has artificially supported the peso at a level much higher than the "real" exchange rate. Anyone who has ever been to Argentina will know there are two currency markets down there; the bank rate and the "blue market" rate. One is set by the bank, the other is set by "the people" (more of a "street" price if you will). These rates have differed by as much as 60% as recently as a month ago. If the bank rate was 6 pesos to the dollar, you could probably get 10 to 1 on the street. Of course, the "blue market" currency exchange is frowned upon, or even illegal, but it has more closely tracked the "real" inflation in the country.

    The whole problem stems from Argentina's energy, trade, and forex policies -- all of which seem almost designed to implode the peso. Argentina imports massive amounts of energy (both gas and oil) to make up for its domestic production shortfalls (note that those shortfalls have nothing to do with the geology or resource base of the country... Argentina is incredibly rich in resources). The shortfalls are the product of years of government intervention (through price controls on domestic producers) in the energy markets which led to a lack of investment in the Argentine energy sector. The energy imports are a MASSIVE drain on Argentina's foreign (US dollar) currency reserves. At some point you just knew that something had to give. Add the artificial support of the peso and heavy trade restrictions on top of the energy deficit and you have a recipe for eventual implosion. What that implosion looks like remains to be seen. It could involve default on foreign debt payments, massive currency devaluation, and even high-level political change

    So, what does that mean for an energy investor in Argentina?

    First off, most operators (e.g., Crown Point) hold the vast majority of their cash in their country of domicile, which is Crown Point's case is Canada. They only send currency into Argentina on an as needed basis, which minimizes the impact of peso devaluation on cash balances.

    As for production, I can't speak for all operators, but in Crown Point's case, my understanding is that they sell their production in US dollar pricing which is then converted to pesos at the bank rate. Essentially, as the "official" peso exchange rate drops, Crown Point gets more pesos per dollar for their oil and gas. That money stays in country and goes towards ongoing drilling & production operations, G&A, local taxes, inventories etc. In that sense, any in-country cash balances would see decreased buying power if they are held for very long, but in general money is put to work as soon as possible in order to minimize that impact. Any peso denominated debt decreases in non-peso terms. All-in-all the direct impacts are largely mitigated by the structure of the business, but the main impact is that discount rates tend to go up at times like this.

    The natural "fear" of investors in the country is "What if Argentina defaults on its foreign debt and people are hauling wheelbarrows of pesos to the store to buy tomatoes?". Well, you can be sure that political and social unrest would likely come into play. Protests in the streets, disruption of services, possibly some lawlessness. But remember this... Argentina is a country that is INCREDIBLY rich in resources. The problem is not with the country or its people, it is with failed economic policies. The sun will still rise and set, people will still love their children, life will go on. In a full-blown default, the IMF would likely get involved. Financial aid and restructuring would be provided in exchange for policy changes and government promises. The government would almost certainly see significant turnover. It's possible that new elections could be held. The restructuring could be a catalyst for a massive influx of foreign investment which should be designed to address the core of the problem... the energy deficit. Trade and forex policies would also likely become much more open.

    So, if you have money in Argentina during a full-blown crisis (and to be clear, this is a "what if" scenario, not a current scenario) what should you do with it? If it were me, I would buy hard assets. Farmland, oil, gas, infrastructure, pipelines, etc... I would want to own "real" assets. In that sense, I think the energy sector is probably one of the best places to be, given that energy is one of the primary inputs to modern civilization. In a financial hurricane, hard assets weather the storm. When the sun comes out again, those assets are still there and still have tangible, indisputable economic value. I may be accused of oversimplifying the situation, but as far as I am concerned, everything else is details.

    Disclosure: I am long CWVLF, .

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Comments (2)
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  • Jan H. Lessner
    , contributor
    Comments (1104) | Send Message
    Interesting point of view. But I would assume that socialist CFK will continue to apply the wrong medicine but more of it. Like her friends in Kuba and Venezuela she will try to tax or expropriate what she can get.
    27 Jan 2014, 04:21 PM Reply Like
  • Malcolm Shaw
    , contributor
    Comments (188) | Send Message
    Author’s reply » Looks like my musings may be put to the test...
    30 Jul 2014, 08:46 PM Reply Like
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