Copper makes up over 50% of Chile’s total exports and the recent rally in the metal bodes very well for Chilean stocks. The iShares MSCI Chile Capped ETF (
Copper Leading The Way
ECH has historically moved very closely in line with the price of copper, the country’s largest export by far. The chart above shows how, despite the recent breakout in the metal, ECH continues to lag, which we think offers an opportunity. The current divergence between copper prices and the MSCI Chile index is among the largest we have seen going back to the early 1990s and a return to the regression line would imply almost a doubling in ECH.
Copper And MSCI Chile Have Been Closely Correlated Over The Long Term
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The strong historical correlation between Chilean stocks and copper exists despite there being very little direct exposure to the metal among companies on the index. Copper prices impact the performance of Chilean stocks in U.S. dollar terms largely through their impact on the currency.
The collapse in ECH since its lofty 2010 peak has been primarily down to the decline in the value of the Chilean peso. As copper prices declined, the country’s terms of trade deteriorated and with it, reducing the fair value of the peso. Despite a two-thirds rally in the price of copper from the March low, the peso has barely advanced and its real effective exchange rate remains deeply undervalued. Even if we had not seen such a strong rally in copper prices, we would expect valuation mean reversion to provide a tailwind to the peso over the coming years. The rally in copper should provide additional impetus.
Chilean Peso Real Effective Exchange Rate: Crisis Level Valuations
Equity Valuations Are Relatively Cheap
Not only should upside mean reversion provide support to the Chilean peso, but it should also help lift Chilean equity valuations. The price-to-book and price-to-sales ratios of the underlying MSCI Chile index continue to trade at levels on par with the 2008 global financial crisis lows, even as book values and sales have been hit hard by the pandemic.
MSCI Chile P/B & P/S Ratios. On Par With 2008 Crisis Levels
While the forward price-to-earnings ratio remains elevated at 24x, investors who are waiting for a recovery in earnings before entering the market are likely to find themselves late to the party given the likely strong recovery in profits. Over 50% of the index comprises of Energy, Materials, and Financials, which tend to have high levels of operational and financial leverage, making them highly susceptible to downturns yet allowing profits to surge during cyclical upswings. The ongoing rally in copper is a strong leading indicator of an economic recovery.
Trading At A Large Discount To Brazil And Mexico
When compared with the other indices in the region, Mexico and Brazil, Chile stands out as being a far cheaper alternative. From trading at a premium to its peers on a P/B basis back in 2010 (around the time of the peak in copper prices) the index now trades at a steep discount.
A Base Is Forming
From a technical perspective, ECH looks like it has formed a base and after breaking convincingly above downtrend support, the path of least resistance now appears to be up. A rally above the 29-30 area would be needed to confirm such a trend change, as that would allow the index to post a higher high as well as push above the pivot point highlighted on the chart below.
ECH Weekly Chart: Bullish Break
Disclosure: I am/we are long ECH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.