Chile and Peru, combined, have about 40% output market share in copper, similar to the combination of the US, Saudi and Russia in oil.
The sharp drop in copper commodity price – down over 30% since early May – and the valuation de-rating of Chile and Peru equities — now on 30-40% discounts to 5-year median forward price/book multiple – may present an opportunity for those with a long-term perspective.
They remain the largest liquid country plays on short-term China stimulus – outside China itself, of course – and the long-term renewable energy transition – which may accelerate as a result of persistently high oil prices and the European shift away from Russian gas.
Context of 4 factors behind the de-rating
(1) Copper price has sharply dropped back to end 2020 levels on global growth (US, China, and EU) fears. But, after an over 30% drop since the start of May 2022, the copper price may be more sensitive to positive news on US (eg job creation) and China (policy stimulus) than further negative news.
(2) US rate hikes, US Dollar strength, and the accompanying global risk aversion have prompted capital flight and currency weakness, particularly in Chile – but the US Dollar is now at its most highly valued, on a spot basis versus other major global currencies or in real effective exchange rate terms, for a decade.
(3) Policy direction under two leftist presidents, Boric in Chile and Castillo in Peru, is uncertain and has led to fears of investor-unfriendly intervention at the micro (copper and lithium mining) and macro (taxation) level – but, regardless of the policy agenda (investor-unfriendly or not) of either president, they are constrained by their lack of control of their respective legislatures.
(4) Copper output is still impaired mainly by labour problems like Covid-related absenteeism and pay-related strikes. But a return merely to 2019, pre-Covid output would imply 9% volume growth for Chile and 7% for Peru from the H1 2022 run-rate.
Quantifying the equities de-rating and FX depreciation
Chile and Peru equity index price/book valuation has de-rated to 30% and 40% below their respective 5-year medians.
Chile's real effective exchange rate (REER), at 77, is at a 10% discount to the 10-year median. Peru REER is close to 100 and at parity to the 10-year median.
Macroeconomic buffers in case of further copper price or output weakness
Low copper prices likely mean that wide current account deficits in Chile and Peru are likely to persist in the near term. This suggests that total external debt (public and private sector) will remain elevated relative to historic levels, over 80% for Chile and over 40% for Peru.
However, short-term external debt remains very low, at c8% for Chile and 4% for Peru, and months of import cover remains comfortable, at 6 for Chile and 16 for Peru.
Fiscal deficits in Chile and Peru widened because of Covid — lower tax revenue and higher stimulus — from 2-3% to 7-8% of GDP. Low copper prices likely means these wide deficits persist for longer than forecast by the IMF in April of this year. However, gross government debt is below 40% of GDP for both.
