A Boom in Latin America a Bubble in Dubai

Bill Bonner - Thu 21 Feb, 2008

Our colleague in Buenos Aires has persuaded us that Latin America is a buy... GDP growth is solid to spectacular. Currencies are rising. These economies are relatively unburdened with the high costs and legacy obligations of Britain and America. And they produce what the world seems to want most – food and energy.

Yesterday, the Dow went up 90 points. But gold hit a new record high. So did the commodity index, the CRB.

What should you do with your money now?

Today, we take a break from our usual cogitations to bring you something useful. A suggestion.

“Sell the US,” we have said.

“Sell the UK,” say our colleagues in London. The English have very similar problems to the US – too much debt, too little profitable output, high costs, little energy, little food. What’s more, the UK economy relies far more on the financial industry than America does.

But today we are feeling positive…helpful…almost earnest. We offer some buy side advice.

Our colleague in Buenos Aires has persuaded us that Latin America is a buy. (Spanish speaking readers are invited to go directly to moneyweekes.com to read his reports unblemished by our bad translations.)

The whole region is booming, says our man in South America. GDP growth is solid to spectacular. Currencies are rising. These economies are relatively unburdened with the high costs and legacy obligations of Britain and America. And they produce what the world seems to want most – food and energy.

“The economy of Peru is gathering momentum,” writes Horacio Pozzo. “GDP growth reached 8.99% in 2007, with a strong growth in consumption (rising at a 7% annual rate) and with outstanding growth in capital investment, at around 23.4%.

“Wherever you look, the Peruvian economy is healthy – with a fiscal surplus of 2.6% of GDP and an external surplus of 1.5% of GDP, with record foreign currency reserves of $28 billion, unemployment of 6.9% and an inflation rate, which reached 3.9% last year, under control.”

By almost every measure, in other words, Peru has a more solidly-growing economy than either Britain or America.

In Brazil, meanwhile, consumer spending is rising too – up 5.5%, compared to an average of only 2.4% in the ‘90s. How come consumers are spending more? Simple…there’s more money in the country and they have more jobs. Earnings have gone up 148% in just the last five years – to a per capital level of $2,794 in 2007. Unemployment has been going down too. It ran into the double digits in 2001 and 2003. Since then it’s been coming down, to the lowest level in the last ten years in 2007 – at 7.4%.

Inflation is still running a bit hot in the Amazon. But the authorities are turning on the air conditioners. The key lending rate of Brazil’s central bank is 11.25% and may go up, as officials try to hold down price increases. And unlike the US president, Brazil’s top man is actually becoming more popular – with approval ratings above 50% and rising.

Money is flowing to Brazil because the country is a major supplier of raw materials and soft commodities – the very things whose prices are rising so sharply. Just last week, for example, Brazilian suppliers got South Korean and Japanese buyers to accept a 63% increase in the price of iron ore. Wheat, of course, is off the charts.

But how do you take advantage of the boom in Latin America…and without getting whacked by a downturn in commodities? Here at the Daily Reckoning, we are suspicious of commodity prices. As soon as you notice a big spike up in a commodity – such as wheat, currently – you have to expect a big spike down. Commodity producers – with some major exceptions – react quickly to price increases. They produce enough to meet the demand…and then, typically, a lot more. Bust follows boom, sometimes so quickly that an investor has little time to get into position.

The 1970s, for example, were boom years for commodities, generally. But the price of sugar actually peaked out at 70 cents per pound in 1973 - at the very beginning of the boom. Marc Faber explains:

“Despite accelerating inflation rates, sugar thereafter failed to make a new high in the 1970s. After 1981, when interest rates fell, the price of sugar continued to decline and bottomed out at 2.5 cents per pound in 1985. And although interest rates continued to decline in the 1990s, sugar was still selling for just 5 cents a pound in 1999…very simply because supplies exceeded demand.”

A boom in commodities is almost always followed by trouble. That’s why our old friend Rick Rule says “most people can’t believe how cyclical commodity markets are.” He goes on to say that in commodities, “either you are a contrarian or you are a victim.”

But Horacio makes a suggestion for how to profit from Brazil’s boom without getting on the wrong side of a commodity cycle.

TAM is an airline with nearly 50% of the domestic Brazilian market. Air transport in Brazil is rising at 10% per year. Yet, TAM sells at a price that is only 4 times earnings. And it has a price to book value of only 1.14.

Buy TAM, says Horacio.

*** London is a remarkable city.

We took the train out to Luton Airport this morning. Standing on the platform at London Bridge Station we watched the early morning trains come in. Out of them came the working classes, people who wear jeans and watch caps and start work early on construction sites, in restaurants and hotels, and in the few other manual jobs that remain in the city centre. Later trains bring in a different class of worker…dressed in suits and ties, who walk across the bridge to the City, London’s equivalent of Wall Street, and spend their days separating clients from their money. Millions of people come into the town centre each day… “I did not think death had undone so many,” remarked T.S. Eliot, watching them make their way over Blackfriar’s Bridge.

The centre of town has become so expensive that few real Londoners can afford to live there. Instead, there are working foreigners, such as your editor, rich Arabs, Russians, French, Indians – all manner of flotsam and jetsam from the globalised, capitalist economy.

England has a tax rule, dating back some 200 years, which allows these foreigners to live in the UK and pay tax only on the money they earn in the country or bring into it. If, for example, a Russian energy billionaire chooses to live in London, his earnings from Russia are tax free here. Naturally, this little feature…along with London’s financial industry and its civilised, law-abiding society...attracts many of the world’s rich and footloose.

Envy is a more potent emotion than the desire for wealth itself. Many people in the UK are annoyed that so many rich people live in their midst without paying taxes. “It’s not fair,” they say, “that we have to pay thousands in taxes on our meagre salaries, while they earn billions and pay nothing.” They have a point. It’s not fair. But it might be smart. Clearly, the rich spread their money around. They fill the fancy restaurants…buy the expensive cars…go to the theatre. They buy property too…lifting the ceiling on the London housing market to the highest level in the world. They also spend enormous amounts of money in England’s equivalent of Wall Street – the City. They have money to manage and invest…they do mergers and acquisitions…the keep the clerks busy. They keep the high-priced lawyers busy…the dress-shop girls on alert…and the jewellery companies hoping for a big sale. (Last year, celebrating an important birthday, we bought Elizabeth a very little bauble at Tiffanys on Sloane Square. Now we are on the mailing list and treated as though we were an oil prince.)

Americans, of course, are in a class by themselves. Unlike the world’s other peoples, the land of the free taxes its own on their worldwide wealth – no matter where they live or how long they’ve lived there. We have lived outside the US for the last 12 years. Yet, every one of those years we filed our US tax return and paid our taxes to the US government - just as if we got something for it.

Curiously, this regime often works to Americans’ interest. An American in Paris, for example, who earns his money in the US, probably pays less in tax than any other group in the city. A special treaty between the US and France permits US citizens - and only US citizens - to discharge their entire French tax obligation on US source income simply by paying the IRS what is owed.

But the non-US, “non-dom” foreigners in London have an even sweeter deal. (“Non doms” they are called…meaning, they are resident in the UK, but not domiciliaries of Great Britain.) It was probably too good to last. Recently, the Labour government buckled to pressure from the voters and introduced a new tax on the “non-doms.” Henceforth, the non-doms will have to pay an annual tax of £30,000 - or about $55,000 - per year, for the privilege of living in the UK.

This amount is peanuts to the Russian billionaires, of course. But there are thousands of ‘non-doms’ to whom it is real money. The City has attracted analysts, fund managers, actuaries and mathematicians from all over the world. There are also large groups of foreigners who have made London their home because it is safer and nicer than where they came from. Whole industries have lodged themselves in London - largely because of the tax feature. A big part of the Greek shipping industry, for example, calls London home.

Now, many of these people say they are leaving. The Greeks say they are going back to Athens. The financial industry says it’s going to Geneva. And all of a sudden, there’s a gush of interest in Dubai.

We don’t know how much effect this new tax will have. But it, along with a decline in the financial industry, makes it a poor time to buy property in London.

*** Speaking of Dubai, a full page ad in a London newspaper announces a remarkable opportunity. “Dubai Property Investment Weekend,” it proclaims.

“Learn about off-plan UAE property and return 40% to 50% of your investment per annum.”

Hmmm…a yield of 40% - 50%? How is it possible? We don’t know, but the ad tells us that we can invest £69,000 and we’ll get an annual return of £33,000.

Ha…ha…ha…ha…ha…

It’s nice to see the markets functioning as they should, separating fools from their money. The actual return from an investment in Dubai property is more likely to be preceded by a minus sign. Colleague Kevin Kerr explains why:

“I haven't been there [to Dubai] before, and know very little about the country. I saw a special on 60 minutes a few weeks ago while trapped on an airplane and saw how that Palm Island is completely sold out but there isn't a soul living there, it's almost deserted.

“I don't think I really grasped how insane it is until I saw some of these pictures and read about plans for a spaceport, yes a spaceport and a 100,000 employee Dubailand. I know this may seem stupid... But where do they get the water (hello it's a desert), electricity, and everything else to support an infrastructure this big? Again, I know we are all aware of the building craze there but I just didn't realise the scope until now. I can't wait to see it in person, or then again maybe I can. I found these…comments on a blog and I couldn't agree more. Yikes.

“The next bubble?

Dubai is said to have currently 15-25% of  all  the world's  cranes.

The Dubai Waterfront. When completed it will become the largest waterfront development in the world .

Allof this was built in the last five years, including that island that looks like a palm tree.

The Palm Islands in Dubai. New Dutch dredging technology was used to create these massive man made islands. They are the largest artificial islands in the world and can be seen from space. Three of these Palms will be made with the last one being the largest of them all.

Upon completion, the resort will have 2,000 villas, 40 luxury hotels, shopping centres, movie theatres, and many other facilities. It is expected to support a population of approximately 500,000 people. It is advertised as being visible from the moon.

The World Islands.300 artificially created islands in the shape of the world. Each island will have an estimated cost of $25-30 million.

TheBurj al-Arab hotel in Dubai.The world’s tallest hotel. Considered the only '7 star' hotel and the most luxurious hotel in the world. It stands on an artificial island in the sea.

Hydropolis, the world's first underwater hotel. Entirely built in Germany and then assembled in Dubai, it is scheduled to be completed by 2009 after many delays.

The Burj Dubai.Construction began in 2005 and is expected to be complete by 2008. At an estimated height of over 800 metres, it will easily be world's tallest building when finished. It will be almost 40% taller than the current tallest building, the Taipei 101 in Taiwan.

More than 140 stories of the Burj Dubai have already been completed. It is already the world’s tallest man made structure and it is still not scheduled to be completed for at least another year.

The Al Burj. This will be the centrepiece of the Dubai Waterfront. Once completed, it will take over the title of the tallest structure in the world from the Burj Dubai.

Recently it was announced that the final height of this tower will be 1200 metres. That would make it more than 30% taller than the Burj Dubai and three times as tall as the Empire State Building. This is a city on crack.

TheBurj al Alam, or TheWorldTower. Upon completion it will rank as theworld's highesthotel.Itis expected to be finished by 2009.

TheTrump International Hotel & Tower, which will be the centrepiece ofone of the palm islands,ThePalm Jumeirah.

Dubailand. Currently, the largest amusement park collection in the world is the Walt Disney World Resort in Orlando, which is also the largest single-site employer in the United States with 58,000 employees. Dubailand will be twice the size.

Dubailand will be built on 3 billion square feet (107 square miles) at an estimated $20 billion price tag. The site will include a purported 45 mega projects and 200 hundred other smaller projects.

Dubai Sports City .A huge collection of sports arenas located in Dubailand.

Currently, the Walt Disney World Resort is the #1 tourist destination in the world. Once fully completed, Dubailand will easily take over that title since it is expected to attract 200,000 visitors daily.

The Dubai Marina is an entirely man made development that will contain over 200 high rise buildings when finished.It will be home to some of the tallest residential structures in the world. The completed first phase of the project is shown. Most of the other high rise buildings will be finished by 2009-2010. The Dubai Mall will be the largest shopping mall in the world with over nine million square feet of shopping and around 1000 stores.It will be completed in 2008.

Ski Dubai, which is already open, is the largest indoor skiing facility in the world. This is a rendered image of another future indoor skiing facility that is being planned.

Some of the tallest buildings in the world, such as Ocean Heights and The Princess Tower, which will be the largest residential building in the world at over a 100 stories, will livethe Dubai Marina. The UAE Spaceport would be the first spaceport in the world if construction ever gets under way. I'm not joking...

Some other craziness... The Dubai Metro system, once completed, will become the largest fully automated rail system in the world.

The Dubai World Central International Airport will become the largest airport in size when it is completed.It will also eventually become the busiest airport in the world, based on passenger volume. There are more construction workers in Dubai than there are actual citizens.”

Colleague Ronan MacMahan says there are ads in the Dublin airport offering a free Bentley if you buy a penthouse in Dubai.

"Apparently, they give you a Mini Cooper if you buy anything at all," says Ronan. "But watch out. There are some one million apartments in the pipeline in Dubai."