Investments at the Edge of the World

Part 2:?Argentinian Revival and alpha ideas

Our adventure started from the colonial past of Latin America, went through the 213-year history of Argentina, and reached the present. Today, the country is at a political crossroads. The new political direction Argentina takes will determine its future.

Three key factors will predefine the state of the Argentine economy:

·??????Political - driving the political-economic pendulum from left to right with the election of a new president;

·??????Argentinian Economy - development of the Vaca Muerta gas field;

·??????Macroeconomics - the core-to-periphery cycle in action.

The choice of a right-wing president and the capital flows to Emerging markets will speed up the development of Vaca Muerta.

The relationship between the factors resembles the triangle of fire - the spark comes from a political power shift; the fuel is the capital from the core (US) to the periphery (Emerging markets); the oxygen is Vaca Muerta. If the three are synchronized, it will ignite the Argentine economy. The consequences will be at many levels - all sectors of the economy will be affected positively in one way or another.

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The always-swinging political pendulum

In recent decades, most Argentine presidents have been Peronists. The following principle guides their management:

Priority is given to short-term populist social reforms at the cost of long-term economic growth.

Typical reforms for them are:

·??????Resource nationalism

·??????High taxes

·??????Moratoriums on prices of goods and services

·??????Expansion of social spending

·??????Nationalization of critical industries

Even if the decisions are fruitful in the short term, they bear expensive consequences in the long term. The elections in Argentina will take place on October 22, 2023. There are still no clear candidates or coalitions, but a few factors provide relative clarity.

Cristina Kirchner is the current Vice President and is significantly more popular than the President. Her approval rating has sharply increased, especially after the assassination attempt against her last year. However, she faces one constraint – she has been sentenced to six years for corruption, which automatically takes her out of the game.

President Alberto Fernandez has shallow popularity according to statistical surveys. Whether his party will nominate him as a presidential candidate is still being determined.

There is intense activity on the right side of the political spectrum. Two names stand out: Javier Milei, a member of parliament, and Horacio Larreta. The latter is the current mayor of Buenos Aires, and both have right-wing political beliefs and are pro-market-oriented.

Suppose the political-economic pendulum is set in motion from left to right with the election of one of the two right-wing candidates. In that case, the likelihood of market-oriented reforms will significantly increase. Part of the necessary reforms is in the mining industry – optimizing taxation, efficient administrative processes, and easier access for foreign companies.

All three would attract more foreign capital to develop the country's natural resources, and Argentina has an abundance of them, which leads us to the next point.

The Dead Cow

The Permian Basin is one of the largest shale reserves globally. Following recent reforms in the United States that restrict shale exploration and sanctions against Russia, there is an increasing need for new sources to meet the demand for fossil fuels.

Argentina has a strong proposition: Vaca Muerta is one of the largest shale reserves in the world. Here are some parameters based on an analysis conducted by EIA**:

·??????Extraction cost - $40 per barrel of oil, $2 per mmBTU of gas. Prices are comparable to those in the US.

·??????Reserves of 27 billion barrels of shale oil and 23 trillion cubic meters of shale gas - both categories rank in the top five in the world.

·??????The deposit’s geology is excellent - shallow deposits, high pressure, and a large percentage of reserves are in liquid form. Hence, the cost of extraction is very competitive.

The main obstacle to realizing this project, typical of Argentina, is political. This is reflected in the current left-wing government. If a right-wing government is elected, the chances of developing Vaca Muerta will increase. Pro-market reforms would attract financing for the project, which would facilitate removing economic and technical barriers.

Gas production from Vaca Muerta has been steadily increasing in recent years - in October 2022, it reached 269,000 barrels of oil per day and 76 million cubic meters of shale gas per day. This is an increase of 42% for oil and 11% for gas compared to last year.

The current limitations have already been reached, and the capacity of the gas pipelines dictates them. The map below shows how they are located. The red line shows the planned pipeline from Vaca Muerta to Buenos Aires, doubling the flow and leading to increased production.

The goals set by 2030 are extracting 700,000 barrels of oil per day and 140 million cubic meters of gas annually. The state will have significant revenues at today's energy prices (as of 01/19/2023, oil at $79, and gas at $3.37).

First, as the owner of YPF, the national oil company, which is currently the most significant player in Vaca Muerta, and second, from taxes imposed on private companies operating in the field. Under a favorable political climate, foreign investors will get involved in the project. Local companies such as Pampa Energia, which have a share of the field, will also prosper. Last but not least is the factor of capital flowing from the core to the periphery, and it can give the necessary push for the political power to invest in the project.

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Core to periphery

The global economy is a living organism; changes in one of its central systems affect all others. The world economy is run by three gears – credit markets, commodity markets, and currency markets. The current decade is the era of tangible assets and emerging markets because the gears are shifting in direction.

The US dollar is likely to depreciate against the currencies of developing countries, which will lead to better conditions for their external debt because a low dollar means cheaper debt servicing. Regarding its indebtedness, Argentina and other export-oriented economies are among the big winners.

Most emerging markets are commodity exporters, and Argentina is no exception. It is among the leaders in agricultural exports, the third-largest producer of natural gas in LATAM (even without Vaca Muerta), and ranks among the large producers of silver and gold.

China's integration into the global economy drove the previous commodity supercycle. Nowadays, we have multiple catalysts to ignite the next commodity bull market:

·??????The capital cycle - decades of minimal or absent investment guaranteed the destruction of current and future supply. In the next few years, supply will not meet the demand, and as we will see shortly, the latter will keep growing.

·??????Renewal of US infrastructure - over $1 trillion budget has been proposed and approved. This undertaking will require colossal amounts of commodities.

·??????The Green Deal Part 1 - no matter how absurd the Climate change narrative is, its evangelists are achieving the opposite of what they aim for. The demand for fossil fuels and minerals will increase even more. Without them, there is no way to produce all the necessary infrastructure for the green "transition." The quantities of base metals, rare earth elements, and energy commodities make the renewal of US infrastructure look like refurbishing a country cottage.

·??????The Green Deal Part 2 - Many "green metals" are extracted and processed in China. If new deposits are not developed, Europe and the United States will become energy-dependent on China. Decades ago, the Western world could afford dependence on OPEC countries because it had some control over them in one way or another. Now, times are different - political-economic fragmentation and polarization reminiscent of the Cold War. That is why more and more investments will be directed towards friendly and neutral countries that possess such commodities. Argentina is among them.

·??????India is climbing the wealth S-curve - the GDP per capita curve does not move linearly upward, and it has an S-shape. Crossing the threshold of $2,300 to $3,300 GDP per capita means that a relatively large part of the population has jumped over the extreme poverty threshold and is moving toward relative prosperity. This means ever-increasing consumption, which requires more and more commodities. China passed through that stage 20 years ago, triggering the previous commodity boom.

Those I have mentioned are long-term factors - they will affect the commodity market in the coming years like the tide raises all boats.

The three factors are closely related and can lift Argentina out of its economic slump. Of these, politics are the most defining. The outcome of this year's elections will determine whether Argentina will take advantage of Vaca Muerta and the movement of capital toward emerging markets.

Argentina Today

It's time to look at the current situation in Argentina. Over the past five years, the Argentine economy has experienced:

·??????A 90% decline in MERVAL

·??????Some of the strictest COVID-19 lockdowns in the world

·??????Another default on its external debt on May 22, 2020

None of these events are separate and independent, and all three are cause and effect in a complex system, such as a national economy.

Following the last default on external debt, the IMF and Argentina found a solution to the crisis. On March 25, 2022, the Extended Fund Facility (EFF) was created - a $44 billion credit line for the Argentine government. In December 2022, the IMF disbursed $6 billion to Argentina from the EFF.

On January 18, 2023, the National Bank of Argentina announced that it would undertake a purchase of part of the external debt for $1 billion. These two events do not solve the country's problems, but they show a willingness to make progress. Inflation remains too high, over 80%. However, a decrease of 95% was recorded during the summer of 2022.

Despite the shocking inflation and unstable economy, Argentina provides unparalleled investment opportunities. From a particular perspective, the uncertainty and instability make these investments attractive.

In the following paragraphs, I will present the Argentinean stock market peculiarities. For the finale, I will give you several companies that have the potential to be among the big winners of Argentina's new rise.

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Investment Ideas at the End of the World

Money always moves from the impatient and unprepared to the patient and prepared. Argentina requires both in abundance. Investing in unknown and high-risk regions is dangerous. The circle of competence works not only at the industry level but also at the geographic level.

The Argentinian equity market is brutally cyclical. Unlike the US or Europe, in Argentina, you cannot hold stocks for decades, realize capital gains, and receive regular dividends. Strategies like buy and hold, dollar cost averaging, and long-term positions for over a few years are contraindicated.

Investing in Argentine companies requires a strict risk management plan that requires active position management. Every quality investment hypothesis has an intriguing narrative, supporting fundamentals, and decisive price action.

The three elements of the thesis carry different informational values:

·??????Narrative - this is the story behind the thesis. We believe in a well-told story more than the most detailed financial report. In other words, we are more irrational than rational.

·??????Fundamentals - these are the numbers behind the story, and they matter because they can hinder the development of the narrative.

·??????Price Action - indicates when to buy, following the phase transition in the price movement.

The narrative consists of three factors - the movement of the political pendulum, Vaca Muerta development, and the core-periphery cycle. The companies I will present will benefit significantly from those dynamics. Those businesses will win if the narrative develops according to my forecast. In addition, they have a strong foundation supported by quality tangible assets that generate free cash flows.

A large part of the companies in the MERVAL index is typical bottom fish - after a 90% decline a few years ago, they are hitting rock bottom. Some of them need the foundation to rebound.

The upper chart is not an exception but a rule. The prolonged sideways movement shows that the stock price is in balance. Using the Big Five of price (direction, magnitude, volatility, time, and plausibility), the balance can be described as a range, contraction, or consolidation. There is a precise balance between sellers and buyers.

The longer the price stays balanced, the more energy accumulates, leading to a phase transition. The price moves from balance to imbalance, and the latter can be described as a trend, expansion, or impulse - one side of market participants suddenly prevails.

The above chart shows the price action of IRSA, one of the companies with huge potential. The price action for the other companies looks the same (except PAM) - ready for a phase transition from balance to imbalance. At this moment, the Big Five are working for me, giving me an asymmetric risk-reward and a slight but sufficient probability edge.

Price action and fundamental analysis are on our side. The companies I will show you have solid fundamentals and high chances, first, to survive and, second, to prosper.

I present six companies - all traded on NYSE through ADRs in US dollars and have good liquidity. Both factors are crucial - there is no need to create an account with direct access to the Bolsa de Comersio de Buenos Aires, nor do we need to buy Argentine pesos and wonder if we can exit the position.

I will not give in-depth analyses but introduce each company with a few sentences. Based on what you have read so far and the description of the companies, you will decide whether it is worth delving deeper into.

·??????Pampa Energia (PAMP) is an integrated energy company that generates and distributes electricity. Additionally, it explores gas deposits, including the Vaca Muerta.

·??????Cresud (CRESY) is a company that produces soy, wheat, corn, and beef. It owns land in Argentina, Brazil, and Uruguay. Additionally, it has stakes in other companies operating in different sectors, such as real estate and commerce.

·??????Banco Macro (BMA) is a commercial bank that offers services to individuals and small and medium-sized businesses and has branches throughout South America.

·??????IRSA Inversiones (IRS) manages a diverse portfolio of real estate properties in Buenos Aires. CRESY owns 57% of the shares.

·??????Mercado Libre (MELI) is the Amazon of Latin America.

·??????LOMA Negra (LOM) is one of the largest cement producers in the country.

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Some of the described companies are included in my portfolio, others are on hold for the first entry, and some are awaiting additional research. You can use the listed companies as a generator of ideas, and remember that only a tiny part of the companies in MERVAL have ADRs listed on NYSE.

In search of Alpha at the end of the world

Argentina is a country at the end of the world and of extremes. A world champion in football and sovereign debt defaults, one of the richest in natural resources, and a leader in consecutive crises.

Argentina is once again at a crossroads - left or right. If the left wins the next elections, the crisis will worsen. A president from a pro-business political faction will not guarantee prosperity, but at least it will give the Argentinean economy a chance to escape the permanent crisis.

I bet on the second scenario, but I know that even the tiniest unknown variable can completely change the outcome. Thus, the described hypothesis is one of the multiple probable scenarios hidden under the veil of the future.

For my investment hypothesis, I work with the following assumptions:

·??????A president from the right political spectrum will be elected - he will initiate pro-market reforms to stimulate the economy.

·??????Vaca Muerta will attract local and foreign investors, boosting the Argentinean economy.

·??????The movement of capital from the core to the periphery will accelerate Vaca Muerta’s development.

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The three assumptions are probabilistically plausible, making the entire scenario plausible to probable using the future cone.

What I know will always be a tiny fraction of the vast unknown. Therefore, my thesis is biased, limited, and incomplete. Read the article as a primer on Argentina through the lens of history, economics, and politics. The future will determine its predictive value.

Argentina is an asymmetric bet among the best. I would compare it to investments in Russia in the early 2000s or Nigeria in the 1990s - complete fog, prevailing uncertainty, and dollars selling for cents.

The businesses I shared with you have solid fundamentals. Their shares resemble much more call options without time decay on attractive assets - from shale gas reserves to top real estate in Buenos Aires.

In conclusion, I will use a quote from one of the most competent financiers when it comes to Argentina - Robert Koenigsberger, Chief Investment Officer at

Gramercy:

Argentina is the gift that keeps on giving.

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This article was originally posted on my website, investo. bg on 24 January 2023.

Next week is the primaries in Argentina (PASO). These outcomes will increase or reduce the credibility of my hypothesis.

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*VOC - Vereenigde Oost Indische Compagnie or the Dutch East India Company. It was a Dutch corporation that laid the foundations of modern corporate finance. Its activities included trade in spices, coffee, gold, timber, textiles, and enslaved people from the colonies of the Dutch Republic. It was founded in 1602 and existed for two centuries. It was the world's first multinational company, with operations spanning several continents. Its existence led to the creation of the Amsterdam Stock Exchange, where VOC securities were traded. The capital it brought to the Netherlands was another reason for creating the Amsterdam Bank, the first central bank.

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**EIA - US Energy Information Administration - the statistical branch of the US Department of Energy. It has a massive database on the geology, economics, and ecology of all economically significant deposits of mineral resources worldwide.

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