The Interview was conducted and originally published on June 9th, 2011 by Mark Wallace on the blog site of Capitalist Exploits.
I finished up the last post by teasing readers with promises of stories of scoundrels, dictators, and intrigue from Carlos Andres. We’re not going to disappoint! My discussion with Carlos at our late night dinner eventually made its way to the Peruvian presidential elections held last weekend. Investor’s worst fears were realized when leftist candidate and self-proclaimed admirer of Hugo Chavez, Ollanta Humala claimed victory.
The nature of politics in a country is important for investors to be aware of, and because I have investments in companies operating in Peru and elsewhere in South America I was especially anxious to hear Carlos' take on the situation. I was hoping it wasn’t as bad as the markets thought it would be…. Keep reading!
MW: Carlos, the news of Humala’s victory subsequently tanked the Peruvian financial markets, including some of your favorite mining and resource companies. We talk about political risk quite a lot, and you’re a student of politics I’m told. Give us your insights on the election and how it went down.
CA: Where to start? Events unfolding in Peru are fascinating in and of themselves, if you have an interest in geopolitics and such. The political landscape is a stew of despotic intrigue with fascist oligarchic leanings on the right, communist sympathies on the left, and a healthy infusion of corruption throughout for extra flavor. Yet Peru thrives economically despite these handicaps. That sounds like the start of a great novel.
From an investors standpoint, the election is a perfect case-study in connection with our previous conversation about profiting on the difference between ‘perceived risk’ and ‘actual risk’. As you said, the news that the ‘extreme’ left candidate won sent Peruvian stocks plummeting. In fact, the shares of companies operating throughout South America seemed to fall in sympathy. This creates a bargain hunting scenario for the discerning investor.
The critical factor of course, is the ability to determine whether the election of Humala will actually lead to the overthrow of the pro-business, mining-friendly, and liberal trade regime that has been built in Peru over the last 20 years, or so. Or, will Humala maintain the status quo, which is an extremely high economic growth rate driven by the countries large natural resource endowment.
For a little background, the Peruvian economy is growing at a rate of 9%, one of the highest rates in the world. It is also the 1st or 2nd largest silver producer in the world, depending on who you talk to. It is the biggest copper producer in the world. It is the 5th or 6th largest gold producer. It is a significant iron-ore producer with large unexploited deposits and a growing oil and gas player. There are even uranium and rare earth element projects sprouting up.
These accomplishments can be attributed, in large measure, to a mature and established mining sector, with a stable, reliable and transparent regulatory and legal framework for companies to rely on. It has encouraged massive foreign investment in Peru over an extended period of time. So, is it Party-on or Party-over?
I think it’s Party-on.
MW: Ok, I’ll bite. Why is it Party-On?
CA: Ok. First we need a little historical context. I’ll tell the story as briefly as I can, but it’s a real soap opera. Going back in time to 1990 you had the rise to power of the right-wing candidate Alberto Fujimori. Yes, a Japanese man raised as a roman catholic, became the president of a Latin country with indigenous Incan roots. You can’t make this stuff up.
Well Alberto Fujimori began the process of promoting free market principals, liberalizing trade, suppressing rebel groups and dramatically improving security and thereby encouraging foreign investment. He however did this in a more or less brutal and dictatorial fashion.
Shining Path and other rebel groups had been reeking-havoc in the rural areas and Fujiomori put a brutal end to their activities, racking-up human rights violations as he went. He also had a fascist or oligarchic bent, meaning corruption was the order of the day. He carved-up the economy for the benefit of friends and family or as payment for political favors.
He brought radical change to Peru, which, despite the means, brought economic stability and growth. It was dubbed “Fujishock” by observers. He was impeached from office a decade later, and wound up in exile in Japan. It’s a long and sordid tale, but he was ultimately extradited and is now serving a 25 year sentence for human rights violations and corruption. Yet, he left a prosperous Peru as part of his tainted legacy. The two presidents that followed Fujimori, Alejandro Toledo and Alan Garcia, more or less continued his economic policies, and Peru has simply exploded.
Remember the name of Alejandro Toledo, because he is an important part of the reason why we believe the party will continue.
Ollanta Humala clumsily enters the story in 2000, with an impulsive and ill-advised coup attempt against Fujimori just days before Fujimori’s impeachment. He was a career military officer at the time, having participated in the brutal suppression of the rebel groups under Fujimori. He is also suspected of human rights violations, but nothing has ever been proven and charges have never been brought.
His coup attempt, which involved other disgruntled officers, failed before it even got started and he became a fugitive. He managed to stay in hiding until Fujimori’s impeachment and was eventually pardoned and reinstated to the military. It makes perfect sense, right?
As a footnote, in 2005, his brother, also a military officer, achieved notoriety by assaulting and occupying a police station in an attempt to force the president at the time, Alejandro Toledo, out of office. Of course it also failed miserably, ending in the death of 4 police officers and one of his compatriots. He was recently sentenced to 25 years in prison for the incident. It’d be comical if it weren’t sad.
Ollanta Humala scares everyone for a couple of primary reasons. On the one-hand he is associated with a native or ethnic nationalist movement, with racist and xenophobic overtones, that has significant support among the military rank and file. On the other hand, he has made it clear that he admires the regions dictators, such as Hugo Chavez of Venezuela, Evo Morales in Bolivia and Rafael Correa in Ecuador, and shares their leftist ideology. This makes foreign capital skittish to say the least. He ran for president in 2006 and lost a close election to Alan Garcia, a former president (back in the 1980’s) of the country. Not to be discouraged, he ran again this year against the daughter of Alberto Fujimori, Keiko Fujimori, and defeated her last week by a small margin in a hotly contested run-off election.
This is truly a case where fact is stranger than fiction.
Ok. Now that all of the actors and the background are in place, we can read the tea leaves and determine which way the winds blow from here.
In Peru, in order to win the presidency, a candidate must win over 50% of the popular vote. Voting is compulsory (required by law) in Peru, by the way. In the first round of the election in April, no one won 50%+ of the vote. Humala lead all contenders with roughly 32% and Keiko Fujimori had 24%. As result, a run-off election was scheduled for June.
Whenever there is a runoff like this between the two top contenders, deals have to be struck with the other participating candidates in order to obtain the necessary votes to achieve a 50% majority. And when deals, have to be struck, compromises have to be made. In other words, ideology gets sacrificed for expedience.
In Humala’s case, he struck a deal with former president (2001 – 2006) and presidential candidate Alejandro Toledo and his party “Possible Peru”. Toledo won 16% of the popular vote in the current election. Well, he is very much a pro-business, free-trade kind of guy; a kinder gentler Alberto Fujimori. As president, he represented much less corruption with a bent towards ensuring that some of the wealth made its way into the rural areas. In fact, he is a western educated economist.
Humala had to make substantial concessions in order to win the support of Toledo’s party. As a result, he softened his leftist stance dramatically. He dropped his pro-Hugo Chavez rhetoric and instead began comparing himself to the very popular former Brazilian president Lula da Silva. Lula, as he is known, was admired for his ability to promote free trade policies that have contributed to Brazil’s boom, while at the same time making sure some of the new wealth found its way to the poorer classes of Brazil. This is a much more palatable model for foreign investment capital.
In a nutshell, Humala did not come to power on an avalanche of public support driven by the desire of the citizens to be rescued from a collapsing economy, like say Hugo Chavez. Instead he has come to power at a time of historic prosperity. Therefore, most folks don’t want to rock the boat. They would just like to see a little more of the wealth make its way to the poorer rural countryside, like in Brazil.
In this context, he was not able to win the election outright and was only able to garner 32% of the popular vote on his own steam. This is a far cry from a mandate for dramatic change and he had to make a deal with a party that has opposing views to his own. As a side note, he was finally forced out of the military in earlier years, and does not enjoy universal support in that quarter either.
Therefore, he simply does not enjoy the kind of universal popular support that would allow him to run rough shod over the economy by nationalizing industries, invalidating trade agreements or mining licenses, etc.
As a result, I believe that the current circumstances represent an opportunity to buy companies with excellent prospects at steep discounts in the near-term. Shrewd, investors can then wait for the smoke to clear in the next 6 to 12 months for a revaluation to former levels. In addition, some of these companies will be achieving important milestones and thereby adding substantial value during this time period, so the potential exists to turbo-charge these returns.
MW: So maybe it doesn’t play out quite as badly as some people think. Normally the best times to buy are when you feel the absolute worst about the situation. That being said, do you have any specific Peruvian recommendations that you’d be willing to share with us at this point?
CA: I currently own shares in a few very promising junior explorers in Peru and I haven’t sold any of my positions as a result of the election, despite the downturn leading up to and through it. In fact, I’m hoping to add to my positions at these depressed prices although I haven’t done so yet. I’m expecting prices to remain soft across the market over the summer for a number of reasons and so I expect to accumulate shares during this time. So, I wouldn’t make any specific recommendations at the moment, but I’ll keep you posted.
MW: Do you see any other “tinderboxes”, places we may want to tread lightly, waiting to catch fire elsewhere in the emerging and frontier markets?
CA: Well, I was very high on Namibia and Tanzania until recently. These have both been progressive pro-business mining-friendly countries. However, both countries have recently made bone chilling announcements about imposing super-taxes or windfall-taxes on profits, and in Namibia’s case making overtures that sound eerily like nationalization. It is too early to tell just how serious these threats are. Just like in Peru, one must carefully parse the tea leaves.
But this is how you can unearth extraordinary opportunity where others don’t dare tread. The same concerns have emerged in the Ivory Coast, where there is a significant mining industry. However, civil violence revolving around a contested presidential election there has put somewhat of a cloud over the industry. Nevertheless, I think there may be a silver lining in that case.
MW: What are the main takeaways for investors operating in countries with above average political risk? What are the warning signs that we might look for to tell us to pack it up and redeploy our capital elsewhere?
CA: I think that if you take a little time to outline for yourself how the power structure works within a country, you can develop the framework you need to evaluate political developments or government pronouncements. Without this kind of background it is impossible for investors to evaluate changes in the political wind direction.
But I would say that you don’t have to become an expert. Simply taking an afternoon (or a day, or a week) to read everything you can find out about a country on the Internet can put you in much better stead to understand what is going on. A few hours of your time, can greatly improve your potential for out-sized investment returns. Once you’ve provided yourself with the background information, you make sure to monitor the airwaves to pick-up on changes that may be brewing.
This works with regard to positive developments as well. For example, those investors who were able to discern the dramatic and positive changes taking place in Colombia in the early part of the century have done very well. Colombia has followed in the footsteps of Peru, albeit a decade behind.
Thanks Carlos! As usual, fascinating stuff. We’ve got a bit more to share with you from Carlos before we let him off the hook. It’s been a fascinating discussion and we’re thankful for all the positive feedback we’ve received on Carlos’s posts. Next week we’ve got a surprise as well, so have a great weekend and we’ll see you here in a few days.
Mark“The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.” – Winston Churchill
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: There are no stocks mentioned in the interview. It is a geopolitical discussion of the outcome of the recent presidential elections in Peru and its likely impact on foreign investment.