ETF Talk: Can Chile Spice Up Your Portfolio?

While I still believe that we are in the midst of a bear market rally, there are plenty of ways to generate profits during this period of unprecedented market volatility. Despite the 33% rally in the S&P 500 since March 9, it is important to remember that the erstwhile index is up only 0.7% year-to-date.

This paltry gain pales in comparison to the rallies in emerging markets. The iShares MSCI Emerging Markets Index (EEM), which duplicates the performance of the stock markets of 26 different countries, is up 23% so far this year. If you typically invest in developed markets, you now may be tempted to buy an exchange-traded fund (ETF) that gives exposure to emerging markets.

For the first time in several decades, economic powerhouses such as the United States, Germany, and Great Britain all saw their GDPs contract by more than 4% last year, when the global economy shrank by 2.1%. During this time, however, Chile’s economy actually grew by 4%. While much of the world was binging on subprime lending, Chile’s conservative fiscal policies restrained unmitigated borrowing, and instead increased the size of the country’s "stabilization fund." With countries such as Japan, the United Kingdom, and the United States borrowing billions to fund economic stimulus packages, Chile is sitting on a reserve of more than $20 billion. This large cash reserve lets Chilean policymakers find easy financing in a difficult market.

Chile also features high levels of personal investment and savings. Almost 43% of Chile’s economy relies on exports and it ranks as the world’s largest producer and exporter of copper. Indeed, a bet on Chile is also a bet on copper.

Although copper has risen in price nearly 30% this year alone, the commodities bust of 2008 is a cautious reminder of what can happen to bubbles. A slump in demand for copper could be disastrous for Chile’s economy. Emerging markets provide the chance for heightened returns, while carrying additional risk.

The chart above shows the iShares MSCI Chile Investable Market Index (ECH), an ETF that seeks to replicate the performance of the Chilean MSCI stock index. Last summer’s commodities bust saw a steep decline in the ETF, as can be seen from the downward trend starting last June and July.

While Chile has many good things going for it economically, ECH is not without risk. Those who believe that copper prices are set to fall in the near future and hurt Chile’s economy should consider waiting for a more opportune time before considering an investment in ECH. In contrast, those who have more confidence in the fundamentals of the Chilean economy might find a long position in this ETF to be profitable.

As always, I am happy to answer any questions that you may have about ETFs. To send a question for me to answer in a future ETF Talk, please click here.