You Can't Like Brazil If You Don't Like China

In last week’s Barron’s, I read the following quote from a fairly prominent hedge fund manager:

*Redacted* “favors emerging stock markets, Brazil and Turkey in particular, over developed markets, but he is bearish on China, citing what he views as ‘extraordinary economic imbalances and the mismanagement of its economy’.”

Let me help you out with that notion, homeboy… Liking Brazil while disliking China is like favoring the Indianapolis Colts in the Super Bowl but betting that Peyton Manning will have a bad game.

I’m hearing this “Brazil is great but watch out for China” thing a lot lately.  It just doesn’t work that way.

China and Brazil are quite possibly the most symbiotic investment story going right now.

It’s completely understandable if you don’t like what’s happening in China, including the crane-filled skylines, the widening gap between those who can and cannot afford city real estate, the ghost cities and the infrastructure being built just for the sake of building.  But if you are a disbeliever in the Chinese boom or its ability to continue, how could you possibly want to invest in an economy like Brazil that is completely beholden to China’s appetite for building materials, finished goods and food?

Brazil’s burgeoning middle class and the rise of their own internal consumer culture are highly appealing to investors, especially when you look at the progress they’ve made in beating back inflation.  But don’t for a minute think that the Brazilian consumer isn’t flourishing as a result of the world’s insatiable appetite for the country’s mineral and agricultural wealth.

Companies like Vale ($VALE) and Petrobras ($PBR) have been coining money by selling to the Chinese Dragon and that same money is precisely what has trickled into the Brazilian population’s purse.

China displaced the US as Brazil’s number one trading partner in 2008; the annual trade balance between the two nations has grown exponentially over the last decade and is now in the range of $36 billion.  In May of 2009, they also signed a $10 billion oil agreement.

Many of China’s steel plants have been running in overdrive since before the 2008 Summer Games.  What made this possible was the metallurgical coal they imported in huge quantities from Brazil (400 million tons last year).  This is in addition to the Brazilian metals and petroleum products shipped to China to facilitate the building of several metropolises and the highways to connect them.  And then there is the agricultural export business, in some ways even more crucial for Brazil, which includes the shipping of soybeans and cellulose products.

The revenues from this relationship have been extremely beneficial to the 90 million or so Brazilians who are now considered middle class (aka Class C).  They buy cell phones, visit dentists and decorate their homes with the dividends from the export business.

And as the US and Japanese economies have retreated over the last two years, Brazil has specifically targeted China as a market to sell into and has become increasingly reliant on it.

What my friend the hedge fund manager doesn’t seem able to connect is the fact that should China’s internal issues cause a blow-up or a slowdown of any consequence, Brazil’s export industry will be perhaps the hardest hit, followed soon after by its consumer class.

And frankly, in the absence of Chinese demand, who could possibly pick up the slack for Brazil’s export industry to keep chugging along?  The US?  LOL.  Europe?  Yeah, ok.

The codependent relationship between China and Brazil is as fundamental as that of the shark and the remora fish.  Any investor who believes otherwise is bound to be heartbroken.

As Old Blue Eyes sang: “This I tell ya brother – ya can’t have one without the … other!”