South American Economies Face Declining Commodity Prices (GML, USO, EWZ, DDP, GSG))

Tony Daltorio: South America’s status as a bright spot in the world economy is under threat as commodity prices fall amid declining demand for raw materials from Asia.

South America’s commodity-rich economies grew at a 5% rate in the first half of 2011. Last year, these economies added half a percent to overall global output.

Slowing Asian demand for commodities have led to plunging prices recently. This is the raising the possibility that the region – which was immune to the 2008-09 recession – may not be so lucky this time.

The SPDR S&P Emerging Latin America ETF (NYSE:GML) is down as much as 30% this year.

Another recession would “hurt more than last time, as there won’t be the same positive effects from (growth in) China and India,” said Sebastian Edwards, former chief Latin America economist for the World Bank.

The effects on lower demand has already shown up in the commodities market. Soybeans, which account for 25% of Argentine exports, have fallen by 11%.

Copper has fallen about 27% year-to-date to less than $7,000 a ton on the LME and below its five-year average price, hurting Chile and Peru, the world’s two largest producers of the red metal.

Oil (NYSE:USO) is important to Venezuela and increasingly to Brazil (NYSE:EWZ). At about $100 a barrel, Brent crude oil is down 20% than this year’s peak and holding only $17 above its five-year average.

If the drop in commodity prices is long-lasting, the effects will felt in several ways. For example, investment in projects, including infrastructure, may dry up and tax revenues to governments will fall.

And, as seen already in Brazil, currencies will fall in value. This will crimp both domestic buying power and consumer credit, two drivers of South America’s booming economies.

“Unfortunately, consumer credit and appreciating currencies are the main drivers of the consumer boom,” said Walter Molano, emerging markets economist at BCP Securities in Rio de Janeiro.

Brazil has started to cut interest rates, from 12.5% to 12%, to try to counteract the declines.

The iShares GSCI Commodity Indexed Trust ETF (NYSE:GSG) and the PowerShares DB Commodity Short ETN (NYSE:DDP) have been virtual mirror images during the past six months, even narrowing their spread since the beginning of the month in concert.

The future for both is likely to depend on the ability of European leaders to settle their debt crisis. A failure to do so could severely damage the world economy, which in turn would hurt demand for China’s exports, and lead the world’s factory powerhouse to purchase far fewer raw materials.

Written By Tony Daltorio For Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market  investments. CNBC Emerging Markets Contributor Tim Seymour leads the  team of Emerging Money to bring you cutting edge global news and  analysis.

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