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The Global Investor Newsletter - Spring 2014

Welcome to the Spring 2014 edition of Euro Pacific Capital's The Global Investor Newsletter. Our investment consultants are standing by to answer any questions you have.  Call (800) 727-7922 today!

The Ukraine Trap: U.S. Russia, Germany and China Play Geopolitical Musical Chairs

                Russian Markets: Crisis or Opportunity

Curreny Action Quietly Heats Up in First Quarter
By: Jim Nelson, Director of Euro Pacific Asset Management

Capitalism Writ Big and Small in Brazil
By: Andrew Schiff, Director of Communications and Marketing

Good Morning Vietnam
By: Russell Hoss, Portfolio Manager EuroPac Asia Small Company Fund

Tonnage Doesn't Lie
By: A.J. Van Slyke, Marketing Specialist

The Global Investor Newsletter - Spring 2014


The Ukraine Trap: U.S.. Russia, germany and China Play Geopolitical Musical Chairs

The 18th Century called: It wants its Eastern European diplomacy back. While the world focused on a potential crisis that could have arisen from a disaster at the Sochi Olympics (which never happened), the Crimean/Ukranian crisis came as a Black Sea surprise that hardly anyone saw coming. But developments there could create globally important economic ramifications for years to come.

The Russians have dominated Ukraine and the Crimean peninsula (part of Ukraine) for hundreds of years. And although Ukraine has been its own country for much of that time, its governments have been almost always directly controlled by, or subordinated to, Russia. The control has been so complete that in the 19th Century Russia was happy to locate its primary naval base on the Crimean peninsula, a move that gave the Russians an all-year window to the Mediterranean and beyond. But in March, when a popular uprising deposed Russia's puppet government in Ukraine, Vladimir Putin lost no time shoring up his strategic interests. His moves have drawn parallels to the "Sudetenland Crisis" manufactured by the Nazis in Czechoslovakia in 1938. In that episode, Hitler exploited the supposed "oppression" of ethnic Germans living in Czechoslovakia to fracture Western alliances and win territorial expansion for his own country. And we all know how that worked out...

What's at Stake 

As the Ukrainian crisis deepens (as more violent pro-Russians increasingly attack strategic targets throughout eastern Ukraine), Russia and the Unites States/EU/ NATO will likely settle into a protracted political standoff. Unlike the late 1930's, however, there is very little chance that it will lead to a continental land war fought with live ammunition. Instead, economic weaponry could be heavily deployed.

At issue is the ability of tens of millions of Eastern Europeans, particularly in the nations that formerly fell behind the Cold War's "Iron Curtain", to drift into the Western sphere of influence. However, this very old conflict does contain some distinctly 21st Century features. The standoff could become a test of strength between the heavily indebted, but financially dominant, developed economies and the resources rich creditor nations of the emerging markets. Instead of mounted Cossacks or Katyusha rockets, the Russians now wield pipelines and refineries.

While it is clear that the West easily out-muscles Russia in financial firepower, Vladimir Putin has the advantage of singularity of purpose and the patience to play the long game. In contrast, the Western alliance is a hodgepodge of competing interests held together by loose legal and political ties. When looked at closely, various fractures emerge within the alliance that will make common purpose difficult. Putin's trump card is Europe's varying degree of reliance on Russian energy.

By seeking to "drive a wedge" between EU members or between the United States and the rest of NATO, Putin may feel confident in his ability to achieve his aims, despite his relatively weak hand. While many in the West dismiss such a possibility as paranoia, the potential for this outcome could make a profound impact on the global economy and, in particular, the energy sector.

While the EU likes to pretend that it is a united economic bloc, in practice the 27 member nations are driven by competing histories, ethnicities, ideologies, and economic necessities. Nowhere is this variety seen more clearly than in energy policy. Nations such as the UK get little to nothing from Russia. On the other end of the spectrum, countries like Poland, Finland, Romania and Hungary get nearly 100% of their oil and natural gas from Russia. Germany sits somewhere in the middle, receiving 37% of its natural gas imports from Russia. For now, at least, Angela Merkel has stood strong against Russia, calling a nullification of the annexation of Crimea to Russia, a withdrawal of Russian troops from the peninsula, and a relaxation of Russian military posturing along its border with eastern Ukraine. But none of these outcomes seem likely without the threat of serious economic warfare.

Europe is Ill-Prepared for an Energy Crisis 

But it is difficult to imagine that the EU countries of Eastern Europe, which are poorer, less self-sufficient, and less able to tap other sources of energy, would be eager to sign up for tough stance against Russia. In the past, Putin has not hesitated to restrict energy deliveries to those neighboring countries that have defied his will. In 2009, Putin literally turned the heat off while Ukraine suffered through a particularly chilly winter. Countries from the Baltic to the Balkins (many of which are unhealthily dependent on Russian energy) will logically fear similar treatment if push comes to shove. Adding to the anxiety is the fact that the vast majority of Russian gas destined for Central and Western Europe is delivered through pipelines that pass through Ukraine. This means that no deliveries can be considered secure if Ukrainian needs become desperate. 

If orders from the Kremlin were to stop, or severely curtail oil and gas shipments, could there be any doubt that a Continent-wide crisis would ensue? As the leading exporter of goods in Europe, German policy seems to be largely focused on the maintenance of open markets throughout the continent. Many argue that the entire Eurozone apparatus has been constructed simply to ensure markets for German manufacturers. Nothing would cut orders faster than an energy crisis. And while many Western politicians have noted the dangers of over-dependence on Russia, the EU has developed energy policies that have only made things worse. 

For the last decade or so, environmental concerns have come to dominate the energy discussion. And while Europe has made huge strides on that front (25% of German electricity now comes from renewable sources), the era of full reliance on renewable energy sources remains in the distant future. But the environmental issue has ironically pushed Europe further into Russia's bear hug. Because of the environmental lobby, European energy producers have not been adopting the hydro-fracking technologies that have transformed oil and gas production in the United States. Similarly, the use of coal, which is relatively abundant in Europe and had provided the bulk of the Continent's thermal needs in the not too distant past, has been cut drastically. Additionally, the Fukushima disaster has greatly discouraged European leaders from expanding their well-established nuclear power capacity. As a result, to meet the power and heating needs of the more than half a billion people in the Eurozone, there seems to be little alternative to the relatively cheap, clean and pipeline-delivered supplies of Russian natural gas. But current events now show the risks that this dependence creates.

Recently, German Economic Minister Sigmar Gabriel seemed to state the obvious by saying that there is "no sensible alternative" to Russian gas. Given the financial realities, there should be little doubt that he was speaking the truth. Currently, Germans pay three times as much for electricity as do Americans. As a result, few politicians see much room for maneuver on any policy that further restricts supply and pushes energy prices higher. Higher prices would be even a harder pill to swallow for those Eastern European countries that are still struggling to hit their strides economically.

America Has Other Concerns 

But with no dependence on Russian energy, the U.S. has an entirely different set of priorities. In fact, an energy crisis in Europe would not push up gas prices in the U.S. (natural gas markets are regional not global). In addition, U.S. manufacturers would gain a competitive advantage against European rivals that would be struggling with higher energy costs. The price that could be paid by America in forcing a confrontation with Putin will not come in the form of higher energy bills, but in lost global prestige. 

Due to a string of foreign policy blunders, President Obama is keenly aware that America is losing its reputation as the guarantor of global security. In particular, the President's failure to take action against Syria's Assad regime when it became clear that it had used chemical weapons showed weakness in the face of Russian opposition. As a result, the President does not want to be similarly rolled over by the nation that we apparently defeated in the Cold War. In order to restore this tough guy reputation, Obama may overplay his hand and be tempted to write a check that must be paid for by the Europeans. If this were to happen, Putin could be provided with a means to exploit these divisions and strike back hard on his Cold War adversary. 

The Trap 

In exchange for promises to contain his expansion into the Ukraine and the former Warsaw Pact countries (thereby soothing fears in Berlin, Prague, and Warsaw), Russia could look to formalize an energy trade agreement in currencies other than the U.S. dollar, the euro in particular. Such a move would help push the global economy into the "post-dollar" world that has long been mentioned by Russia and China. It would also burnish the reputation and stability of the euro, which has come back strongly from the drubbing the currency took as a result of the European sovereign debt crisis. Such a deal that marginalizes the United States would be a crowning achievement of the Putin regime. In April, Platt's Energy, a leading journal of the energy industry, reported Andrei Kostin, the president of VTB, Russia's biggest state-run bank, as saying, "It is time to change the entire international financial system that considers the dollar the key reserve currency." Kostin was reported to be in talks with major Russian energy providers such as Gazprom and Rosneft whose eagerness to make a change has been catalyzed by the Ukrainian conflict. Alexander Dyukov, the head of Gazprom's trading arm, said that 95% of his customers were ready to switch their dollar-based contracts into euros. 

The fulcrum for any potential shift in the status quo may be found in Germany. In the 70 years since its defeat in the Second World War, Germany has been largely content to function as a loyal soldier in the Anglo-American led Western alliance. But in recent years, Germany (a creditor nation) has often found herself isolated from her debtor nation allies on questions of central bank and fiscal stimulus. As a result, it is not too difficult to foresee a situation where Germany becomes less willing to go along with NATO on energy and financial policy. A May 2 front page story in the Wall Street Journal detailed a series of unusually frank public comments from leading German industrialists urging Chancellor Merkel to refrain from imposing additional sanctions on Russia. This comes just two days after the WSJ reported that in late April Vladimir Putin attended a birthday celebration in St. Petersburg for former German Chancellor Gerhard Schroeder. It appears that the two remain on friendly terms.

A recent poll of Germans revealed that more (49%) wanted their country to mediate between the U.S. and Russia over the Ukraine, rather than simply back up American policy (45%). The same poll showed that a majority of Germans objected to the regular presence of NATO troops in countries that border Russia. Pushing back against the Americans on this issue could provide Germany the European leadership role that she has been pursuing since Bismarck.

The Eastern Option 

But even if the EU were to resist the enticement of energy trading in their own currency, and instead were prepared to hang tough in order to teach a lesson to the bully in the Kremlin, there is reason to believe that Russia would simply look for new customers, particularly in China. By failing to criticize Russian actions in the Ukraine (China has said very little on the crisis and was recently absent at the UN vote in which the secession referendum in Crimea was declared illegal), China may be setting itself up as the beneficiary of a disruption of Russian-European gas deliveries. Bilateral trade between Russia and China has taken off in recent years, and the two countries have been cooperating diplomatically on a number of fronts. In February alone, China imported 2.72 million metric tons of Russian crude oil, a monthly pace that has more than tripled in a decade. Customs data indicates that China imports approximately 12% of its crude from Russia.

There can be little doubt that as China's energy needs explode, the country will be forced to reduce its overdependence on coal (70% of its energy supply), which is creating unsustainable environmental stress on China's citizens. Pollutants pouring from coal-burning power plants are turning many of China's biggest cities into unlivable smog pits. This will have to change. According to an April 14 Bloomberg article, the Ukraine crisis increases the chances Putin will sign a long negotiated 30-year deal to supply pipeline gas to China.

Major pipeline construction has already begun that will allow Russia to pipe gas to China that it currently sends to Europe. As the capstone of increased energy trade, Russia and China could agree to a deal to trade energy in the Chinese RMB. Such a move would shift much of the globe's economic gravity further into China's orbit, and would help the RMB take a step forward to global reserve status. As would be the case in a euro-based energy trade deal, this scenario would be detrimental to the U.S..

In any event, the crisis now unfolding contains many more seeds for bad outcomes than the financial commentators understand. If the Obama Administration falls into a trap and misplays the situation, it could see stronger ties between the Russian Federation and EU or Russia and China. Either way, it moves us closer to the "post-dollar" world that many have predicted.

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Russia Markets: Crisis or Opportunity

Who said geo-political aggression is bad politics? Russian President Vladimir Putin's domestic approval rating surged to 80%, a five-year high, after his annexation of Ukraine's Crimean peninsula in March. But that patriotic fervor may be short-lived as the Russian people feel the economic repercussions of Putin's move to restore what he called a historic injustice inflicted by the Soviet Union 60 years ago.

Even before Putin's Crimean adventure and the West's subsequent imposition of economic sanctions, Russian's $2 trillion economy was sick. In contrast to the improving economy in the Eurozone, Russia's growth rate "tumbled from 3.4% in 2012 and a projected 3.6% for 2013 to just 1.3%" last year, said the World Bank in its Russia Economic March 2014 report. With consumer confidence falling, inflation rising and growth falling, the economy was already suffering from the toxic mix known as stagflation. As a result, economic repercussions that may result from further deterioration in Ukraine could push Russia into recession. 

For now, however, U.S. sanctions have been limited to freezing the U.S. assets of government officials and friends of Putin. Russian gas producer Novatek saw its stock plunge after Putin's friend, Gennady Timchenko, landed on the sanctions list. With Timchenko owning 23% of Novatek, investors feared it wouldn't be able to raise capital or do deals. Following the sanctions, Standard & Poor's Ratings Service and Fitch Ratings cut their outlooks on Russia to negative from stable. Both reaffirmed their triple-B ratings, two notches above junk bond status, but suggested these could be cut in the near future as Western banks shied away from lending to Russia.

With President Obama giving Treasury Secretary Jack Lew the ability to place sanctions on Russia's "financial services, energy, metals and mining, engineering, and defense" industries, the overall business climate is one of gloom.  In its March report, the World Bank proposed two growth outlooks depending on how the crisis pans out. The bank expects consumption growth to slow and stabilize below previous levels, and that "the rate of growth would be increasingly dependent on the recovery in investment demand."

By late April, the pain was worsening. With inflation rising, Russia's central bank raised interest rates to 7.5%. Then Standard & Poor's Ratings Services downgraded its rating on Russian sovereign debt to BBB-, just one notch above junk-bond status. S&P said if economic growth continues to deteriorate and more sanctions were imposed it would consider more downgrades. Finally, on April 28, the U.S. instituted its second round of sanctions. It froze the assets of, and prohibited any Americans from dealing with, seven Russians and 17 companies closely associated with Putin. In addition, exports related to Russia's military were restricted. For its part, the European Union sanctioned 15 people.

But a recovery in foreign investment and lending seems unlikely soon as foreign investors, afraid of more sanctions, pulled billions of dollars out of Russia. RT, Russia's English-language news channel, reported that $50.6 billion had left the country in the first quarter of 2014, compared with the $120 billion that left Russia during the 2008 crisis. The World Bank suggested that another $150 billion could leave by the end of the year.

This caused the ruble to weaken, the Russian stock market to plunge, and a 150-basis-point jump in Russia's benchmark interest rate to 7%. On April 20, the ruble stood at 35.58 to the dollar, up from its March low of 36.58, but still 8.3% down year-to-date.The stock market's benchmark Russian Trading System Cash Index (RTS) (Bloomberg RTSI$) fell in March to a five-year low of 1063, or 26% from its close last year. After a small recovery, it's still down 17% year-to-date.

Assuming a short-term impact from the crisis, the World Bank projected growth will drop to 1.1% in 2014 and recover to 1.3% next year. The bank's high-risk scenario of a severe shock to Russia's economy projected a contraction in output of 1.8% this year.

The high-risk scenario assumes the following factors would hurt investment:

  • Large companies' access to international markets would become increasingly restricted, leading to a scale down in investment programs.
  • Russian banks would face new restrictions in accessing international capital markets causing credit activities to decline.
  • Foreign investors would see risk rise as profit margins fall, leading them to pull out more funds.
  • Exchange-rate volatility would intensify, making borrowing more expensive.
  • Banks' credit portfolios would deteriorate faster, leading to higher borrowing costs and higher consumer credit defaults.

On April 17, RT Business reported Russia's Finance Minister Anton Siluanov said that 2014 GDP growth could potentially fall to 0%. He further added the current environment was "the most difficult conditions since the 2008 crisis," and that Ukraine's sinking economy could bring down Russian companies that were heavily invested in its neighbor. But one person's crisis is always another person's opportunity. Is this the case with Russia?

With the Federal Reserve signaling that it plans to hold U.S. interest rates near 0% for another year and the yields on U.S. corporate junk bonds falling to near-record lows, investors of distressed debt may be soon attracted to Russian corporate bonds. According to J.P. Morgan Chase & Co. index data, the yields on Russian dollar-denominated corporate bonds have risen 24% this year to 7.2%. Will such levels be enough to entice foreign investors to take on the risks? Even as the Ukraine situation deteriorates, investors may believe that the economic sanctions are unlikely to push Russian companies or the government into default. If that belief solidifies, the bounce back could be profound. As a comparison, when Russia defaulted in 1998, the spread of Russian bonds over U.S. Treasurys reached nearly 7,000 basis points. But within five years the spread had come down to 223 basis points. (The Economist, 10/9/03 article)

The fast-motion collapse of the loudly trumpeted cease fire agreement that was negotiated by the EU, the U.S. and Russia in late April is a strong hint that the crisis will get worse before it gets better. While we do not expect a replay of the Eastern European diplomatic spiral that led to the First World War (the 100th anniversary of which is just four months away), investors should be wary. But we expect that the day will come when Russian assets are truly attractive, and that the opportunities outweigh the risks.

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Currency Action Quietly Heats Up in First Quarter

By: Jim Nelson, Director of Euro Pacific Asset Management

In recent months the surprisingly strong moves made by some currencies have largely been lost amidst the big picture financial developments thus far in 2014. It may surprise many Americans but in May of 2014 the U.S. dollar hit a five-year low against the British pound, and approached a nearly three-year low against the Swiss franc (notwithstanding three days in March that traded slightly lower). The weakness in the dollar portends a weaker U.S. economy and a strong likelihood for more Quantitative Easing from the Federal Reserve. If the markets can maintain a focus on fundamentals, we would expect these trends to hold for some time. Unfortunately the currency market often defies logical explanation.

Of the developed market currencies, the New Zealand and Australian Dollars have led the upward charge this year. Through mid-April the Kiwi has taken the top spot by adding nearly 6% against the U.S. Dollar. There can be little doubt that much of this success resulted from New Zealand's decision in March to become the first developed nation to tighten monetary policy since the financial crisis of 2008. Significantly, they did this in the face of criticism by mainstream economists who had argued that New Zealand's currently low inflation level (just 1.5%) should have prompted looser monetary policy to guard against deflation. By ignoring the admonishments of the Krugmans of the world, the New Zealanders appear to have given their currency a brighter future.

The good news for New Zealand is that its economy is doing fine without monetary stimulation. Strong commodity and dairy prices, construction (much of it tied to the NZ$40 billion Christchurch earthquake rebuild), and strong immigration have all contributed to the positive economic data. In such an environment, bankers at the Royal Bank of New Zealand have vowed to keep tightening. Analysts are looking for another 2% increase in interest rates over the next two years, bringing the cash rate to 4.5%.

This is a stark contrast to the rest of the developed world that vows to keep rates close to zero for the foreseeable future in order to fight the non-existent threat of deflation. 

For its part, the Aussie Dollar is up 5.5% year-to-date (through mid-April) and has had one of the best risk-adjusted returns of foreign currencies over the last 3 months (it has shown relatively little volatility - and is up almost 7.5% from its January low). Despite this, it is still 15% below its highs against the U.S. Dollar achieved in July of 2011. While many predicted that a slowdown in China would be a major blow to Australia's export-driven economy, the country has proven far more resilient than it was in 2008, when global troubles bled into Australia and pushed the Aussie Dollar down nearly 40% in just a few months.

Despite the lumps the currency took in 2013, the Aussie has a lot on its side. Australia boasts the highest interest rates and lowest unemployment rates of any major developed economy. Central Banks have taken notice, increasing their reserve allocations to the Aussie Dollar. With inflation in Australia approaching 3%, many believe that the country is in line to raise interest rates, an action that would add more momentum to the currency. 

On the other side of the world, our favored Scandinavian currencies have not seen such smooth sailing. The Norwegian Krone is off 2% and the Swedish Krona is upa little more than 2%.The divergence can be explained by the disparate effects created by resurrection of confidence in the Eurozone and the belief that the problems of the European Monetary Union are in the past.

Despite the economic calm that has descended over Europe, the Euro itself faces some headwinds. Very large structural imbalances remain on the Continent, and record low bond yields across the peripheral and core nations of the Eurozone have allowed many countries to pretend that their fiscal problems have been solved. Deflation remains a key concern, along with a Eurozone unemployment rate that hovers near an unsustainable 12%. As a result, many expect Mario Draghi will unveil a Quantitative Easing program similar to the one that the Federal Reserve has pursued for the past 5 years in the United States. 

The prospect of the European Central Bank buying EU bonds has put a great amount of wind in the sails of euro denominated debt. This may encourage some investors to snap up the 3% yielding sovereign bonds currently being issued by Italy and Spain, or perhaps the 6% yield on the new five-year Greek government bonds. Given that Sweden is a member of the European Union and is tied more closely to the Continent's economy than is Norway, some of the money going into the southern tier may be at the expense of Swedish bond investments. After all, if Italy offers similar implied protection to bond investors as lower-yielding Sweden, why not go for the higher payments? Norwegian bonds, which are likely to draw more investment from those seeking to avoid EU entanglements, are not likely hurt in the same way.

Norway, with a much less liquid currency than the Euro or Swedish Krona, has been bolstered by the Norges Bank (Norwegian Central Bank) holding interest rates firm at a respectable level of 1.5% for the last two years. Underlying CPI has been rising, supported by wage pressures from an ultra-low unemployment rate. This has led to the currency's appreciation in 2014 after a trying year in 2013. We expect Norway to continue to benefit from its unique position in the global marketplace. 

Within emerging markets, the Mexican Peso has maintained its value this year essentially unchanged after a broad emerging market sell-off at the start of the year and an Argentinian currency devaluation that weighed particularly heavily on Mexico. Falling Mexican inflation since January has put currency traders at ease, allowing the Peso to bounce back nicely. In addition, energy sector reforms have attracted attention from international investors, combined with the prospect for interest rate hikes this year after last year's rate cuts.

Moody's upgraded the Mexican government's bonds to "A3" from "Baa1" on February 5th, providing further evidence of investor support for the nation's economic policies. On February 22nd, the arrest of Joaquin "El Chapo" Guzman, considered the world's most powerful drug kingpin, is also testament to government reforms.
There is likely to be further development of some of these themes in 2014, although a rocky geopolitical landscape (particularly focused on the Ukraine) could add volatility, and changes in liquidity due to Central Bank actions are also to be expected. More observable inflationary pressures in some foreign economies raise the prospects for rate hikes, helping to fuel interest among domestic investors to add exposure to foreign currencies. Hopefully the strong fundamentals will continue to be the driving story for the remainder of the year.

Foreign investments present risks due to currency fluctuations, economic and political factors, lower liquidity, government regulations, differences in securities regulations and accounting standards, possible changes in taxation, limited public information and other factors. The fluctuation of foreign currency exchange rates will impact investment returns.  

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Capitalism Writ Big and Small in Brazil

By: Andrew Schiff, Director of Communications and Marketing

This year the French neo-Marxist professor Thomas Piketty achieved "rock star" status on the global stage by asserting in his new book "Capital in the 21st Century" that unrestrained capitalism (particularly of the large corporate variety) impoverishes the masses by allowing wealth to increasingly concentrate at the very top. The David and Goliath aspect of this populist provided a welcome arithmetic gloss for people who harbor a fundamental moral revulsion for others who amass great wealth. However, a recent trip I took to Brazil, tied to my participation in the 27th annual Liberty Forum of the Institute of Entrepreneurial Studies (IEE), allowed me to heighten my understanding of how important very big capitalism can be for an economy.

By any standard, Brazil is a country that has yet to live up to its economic potential. The fifth largest country in the world as measured by both land mass and population, the country has seemingly endless natural resources and an energetic and growing population that has recently been estimated to have topped 200 million. Nevertheless, according to the International Monetary Fund's World Economic Outlook Database (2013), it ranks 79th globally in terms of per capita GDP. After just a few days in the country it's easy to see why.

The first thing I noticed is the overabundance of the entrepreneurial spirit. That's right, in left-leaning, quasi-socialist Brazil, capitalism is everywhere and inescapable. It hits you when you walk down the street, go to the beach, hail a taxi, or sit in a restaurant. From my perspective it appeared as if Brazilians were ceaselessly involved in unregulated commerce, selling everything you could possibly imagine, everywhere you could imagine it being sold. Do you need a chaise lounge and an umbrella for the beach you just stumbled on? No problem, a couple of vendors stand ready to offer you some options...price negotiable.  You want a freshly made melted cheese bun on the chaise? No problem, the vendor is on his way to set up his portable charcoal oven. Oh, you want a cocktail with that?  That caipirinha guy is on his way, ready to mix up rum, limes, fresh fruit, and mint from his portable bar tending stand (and no, he doesn't need to see your ID).

In the center of most cities, lunch is sold from the back of hatchbacks, plastic tables are laid out by whomever gets there first, and commerce happens incessantly without any seeming interference from the authorities. I witnessed hundreds of vendors, who would have been sent packing by police in less than five minutes on the streets of New York, operating freely on the crowded streets and beaches in Salvador, Bahia. All the vendors who I was able to communicate with told me the same thing... in Brazil nobody cares how you try to make money...the local cops may want a bribe here and there but they don't see it as their job to enforce civic codes and public morality. This attitude is consistent with the free-spirited nature of the Brazilian culture. However, this tolerance ends when capital starts to accumulate and business gets big. At that point, the government steps in with a very heavy hand.

At the conference I attended in Porto Alegre, the Brazilian industrialists and economists I spoke with offered a very consistent lament: Opening a real business in Brazil is a bureaucratic and operational nightmare created by an over-concentration of power in a corrupt distant capital that is dominated by a political class with a consistently anti-business philosophy. As a result, Brazil ranks 100th in the Heritage Foundation's Index of Economic Freedom. This puts them below such capitalist wonderlands as Tanzania, Honduras, and Cambodia. But the news gets worse from there.

According to the 2013 data compiled by the World Bank, it takes an entrepreneur more than 108 days to  cut the red tape necessary to open a business in Brazil. This figure puts the country at third worst position worldwide (after those other South American dynamoes: Venezuela - 144 days, and Suriname - 208 days). Of course this does not count those few countries like Cuba and North Korea where it is illegal to open a business at all. In contrast it takes just 33 days to open a business in China, 14 days in Israel, 5 days in the United States, 3 days in Australia, and just a single day in New Zealand. The people I spoke with were desperate to change this reality in Brazil, but felt largely powerless against a democratic establishment in which the interests of medium and large businesses were held in such low regard. There can be little doubt that the leftist government of Dilma Rousseff in Brasilia would be eager for Mr. Piketty's book to be translated into Portuguese so that even more Brazilians can be convinced that big capitalism needs to remain in check.

But a society is only as good as its tools. And the tools that permit higher living standards, factories, innovative businesses, distribution capacity, can only be built through the large scale accumulation of capital, which is precisely the activity that Mr. Piketty and his supporters believe is so dangerous. The small scale capitalism that flourishes in Brazil can make life much more enjoyable, but it has a limited ability to generate the increases in productive capacity that allows wealth and higher living standards to take place. The spirit is clearly there. It just needs to be unleashed.  

In order to maximize the productivity of labor and raw materials, big tools and big systems are needed. Factories, machinery, distributions systems, communications all help to give us more for less. These types of systems can be built only through the accumulation of large amounts of capital combined with the confidence to invest the funds in a long term enterprise. Without that kind of capital formation, all we have is our personal abilities to, among other things, make cocktails and melt cheese.    

In Brazil a series of populist governments have vowed that the public sector is better able to handle the economic heavy lifting. But their massive failures have proven time and again that the planners in Brasilia do an awful job in tackling the challenges that they prevent big business from handling. Although the country's health care and educational systems are rightly and universally ridiculed, it is the woeful infrastructure that presents the biggest problems for the country. The lack of adequate roadway and railway capacity has largely prevented Brazil from putting its staggering resources to work. Instead of using its resources to change this, the Brazilian government decided unilaterally that that money would be better spent on the airports, stadiums and athletic facilities needed for this year's World Cup and the 2016 Olympics. And while "futebol" is an easy sell on the campaign trail, it's not the right medicine for Brazil's ailing economy. (It is widely believed that Brazilian taxpayers spent more money on corruption in these mega-sports projects than on the projects themselves). 

But their efforts to keep capitalists in check have produced little of the equality that today's neo-Marxists so earnestly demand. Brazil remains a country where barricaded luxury apartment buildings stand cheek by jowl with shanty towns. The only result of the country's populist political strain is persistent poverty and underachievement. The leaders of the IEE are hoping that the country can soon wake up to this reality, ideally in time for this October's presidential election. I wish them luck. But as with other South American countries like Argentina, Venezuela, and Ecuador, Brazil seems to be overly susceptible to charismatic, populist demagoguery. It seems that may be a tougher habit to break than a noonday caipirinha in the shade.

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Good Morning Vietnam

By: Russell Hoss, Portfolio Manager EuroPac Asia Small Company Fund

While the world seems to be lurching forward to another geopolitical crisis, it's a safe bet to assume that most Americans believe that foreign markets are as risky as they have ever been. And while some of the more high profile countries like China, Japan, Russia and Brazil are encountering some of the most significant headwinds that they have seen in recent years, other countries are enjoying much less heralded success. From our perspective, one of the world's best current success stories is occurring in Vietnam.

While most Americans still equate with the country the poverty seen in war films like Apocalypse Now, the country now has some of the most impressive economic fundamentals in the world. With 90 million people, Vietnam has the third largest population in Southeast Asia, after Indonesia and the Philippines. More importantly, its middle class is on the rise. A December study from the Boston Consulting Group expects that the number of Vietnamese who are considered "middle class" will triple to 33 million by 2020. (PlasticsNews 4/10/14) Relative political stability coupled with growing companies, high dividends, and decent valuations should qualify Vietnam as an attractive target for Americans who can tolerate the risks of international investing.

A look at the economic and market performance numbers posted by Vietnam in 2013 buttresses the story. In stark contrast to the lackluster numbers that we have become habituated to in the developed world, Vietnam saw GDP growth of 5.4% (it has averaged 5.7% growth over the last five years), and a 15.4% increase in exports. Meanwhile its public debt to GDPratio stands at a manageable 56.2%, almost half the figure that is burdening the United States.

Based on projections compiled by Bloomberg, 2014 is shaping up to be another strong year for the Vietnamese market.Earnings per share are expected to rise an impressive 19.7%, and price to earnings multiples are expected to decline to 10.5 from the already low level of 12.6 seen in 2013. [(P/E of the S&P 500 stands at just under 19). It's important to consider that Vietnam has been able to achieve these results with real interest rates that are 300 basis points above the rate of inflation. In contrast, the U.S. markets have enjoyed the benefit of negative real rates for years. The cherry on the cake is Vietnam's healthy 4.1% dividend yield, which is more than twice the yield of the S&P 500.

We expect that the growth estimates about Vietnam's economic future may even be a little conservative, particularly if the country ratifies the 12-nation Trans Pacific Partnership (TPP) agreement. This pact, which Vietnam is expected to ratify in 2015, could bring the country into a trade partnership with the most prosperous nations on both sides of the Pacific.However, the blockage of the agreement could be a significant risk factor for Vietnam-based investments. Already the country is starting to move into a key player role in world trade. South Korea's Samsung, the world's largest manufacturer of mobile phones, now makes half of its 250 million handsets in Vietnam. (PlasticsNews 4/10/14)

Vietnam is also set to reform financial regulations to allow for increased foreign ownership of equities (currently capped at 49% for public corporations and 30% for banks). This will allow for easier investment into the country's many different corporate sectors including basic materials, utilities, energy, infrastructure, real estate, and agriculture. But the most important news for investors is the country's plans to privatize 432 currently state-owned enterprises (SEOs) that together account for 35% of the country's GDP. While many of these companies may remain far too inefficient to consider as good private investment targets...the cream of the crop may ultimately rise to the top. The key is patience.

We believe that the performance of countries like Vietnam is proof that meaningful economic growth can't come from a printing press, but must be earned by hard work and real investment.

Foreign investments present risks due to currency fluctuations, economic and political factors, lower liquidity, government regulations, differences in securities regulations and accounting standards, possible changes in taxation, limited public information and other factors. The risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

Foreign investments present risks due to currency fluctuations, economic and political factors, lower liquidity, government regulations, differences in securities regulations and accounting standards, possible changes in taxation, limited public information and other factors. The risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies. Due to the limited focus of this fund, the fund is more susceptible to market volatility because smaller companies may not have the management experience, financial resources, product diversification and competitive strengths of larger companies. Additionally, smaller company stocks tend to be sold less often and in smaller amounts than larger company stocks. More information about these risks and others can be found in the fund's prospectus.

You should carefully consider the Fund's investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus, each of which contains this and other information about the Fund, please visit  www.europacificfunds.com or call (888) 558-5851. Please read the prospectus or summary prospectus carefully before investing or sending money. 

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Tonnage Doesn't Lie

By: A.J. Van Slyke, Marketing Specialist

The World Bank issued a report in late April that  suggested that China is now poised to surpass the United States as the world's largest economy as early as this year. Critics downplayed the report by questioning the validity of purchaser power parity (PPP), the economic metric upon which the World Bank based its conclusion. While it is often difficult to trust government-supplied data and academically-analyzed statistics, sometimes there can be no substitute for raw quantity to draw a clear conclusion.

For those looking for a no-nonsense approach to economics, we suggest looking at freight volumes. The amount of material flowing out of a region's maritime ports can tell an observer a great deal about the underlying economy. A quick look at port data from the last two years in the United States and China reveals a tale of two economies. One country is surging, while the other is faltering. It's no great mystery which is which.

As you can see, the China trends look very good. Out of the last nine quarters (beginning in Q1 2012 and ending in Q1 2014), total trade volume in Chinese ports has reached 4% or more (year over year) four times. One of those quarters (the most recent - Q1 2014) saw an increase to more than 7%! There is also evidence of a strong upward trend currently taking hold. Volumes have increased for five consecutive quarters (beginning Q1 2013). In only four quarters of the last nine have volumes declined or remained steady, and only once (Q2 2012) did they drop by more than 1%. 

In addition, China shows a healthy balance between imports and exports. On only three occasions did the volume changes for each go in opposite directions, and when the disparity did occur the gap was small. The biggest difference, about one and a quarter percent, occurred in Q4 2012, when imports dropped by just over one percent and exports gained about a quarter of one percent.

In contrast, the United States looks like an economy running out of steam. Of the last nine quarters, total volumes increased by 3% just once, and by 2% on just two other occasions. In all other quarters, volume either dropped or increased by marginal amounts.

In contrast to China, exports are the far weaker side of the equation, and have declined in the U.S. by at least one percent for five of the last seven quarters (with three of those declines coming in at more than 2 percent.)

In the U.S., imports and exports seem to diverge more frequently. On four occasions over the last six quarters imports have been up while exports have been down. And when this happens, the divergence has been much greater than what is seen in China. For instance, in Q4 2012 a four percent gap emerged when imports increased more than two percent and exports declined by more than two percent. 

The U.S. trade volume chart does not paint a picture that corresponds to the recovery talk that dominates Wall Street. Should this surprise anyone?  

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Investing in foreign securities involves additional risks specific to international investing, such as currency fluctuation and political risks. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. This material is for private use of the subscriber; it may not be reprinted without permission. The opinions provided in these articles are not intended as individual investment advice.

This document has been prepared for the intended recipient only as an example of strategy consistent with our recommendations; it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investing strategy.  Dividend yields change as stock prices change, and companies may change or cancel dividend payments in the future.  All securities involve varying amounts of risk, and their values will fluctuate, and the fluctuation of foreign currency exchange rates will also impact your investment returns if measured in U.S. Dollars.  Past performance does not guarantee future returns, investments may increase or decrease in value and you may lose money.

Opinions expressed are those of the writer and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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