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Time to Worry about the Chile ETF?

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The Chilean economy has always been export-centric due to its strong commodity focus. In particular, copper plays a huge role in the economy, as the country produces nearly one-third of the world’s total output. The country’s government also owns and operates Codelco, the largest copper producing company in the world.

As a result, the recent decline in copper prices has gone a long way to hurt the Chilean economy. Also, the constant decrease in industrial production in China – the world’s second largest economy and one of Chile’s largest trading partners –remains a cause of concern.

China Connection

China is a major user of copper and is in fact the world’s biggest importer of that metal. Nearly one-fourth of all Chilean exports are shipped to China, which makes Chile’s economy vulnerable to changes in Chinese trading patterns (read: If China Slumps, Avoid These Three Country ETFs).

With China’s import of copper falling to the lowest level (down 21.2% y/y and 7.4% q/q in Apr 2013) in almost two years owing to the waning domestic demand for metals, Chilean strength seems to be decreasing too. After all, copper comprises more than half of Chile’s exports, an 8.2% drop in its prices this year through May 17, could hurt the country’s economy.   

Also, adding to its woes are a higher peso and the country’s general slowdown. The peso traded between CL$521.25 and CL$465.75 last year and is presently hovering around CL$492.5, up about 5.7% from the 52-week low (as of May 29, 2013). The strong currency has spoiled the country’s export efficiency to some extent.

Further, Chile’s economic expansion was lower-than-expected in the first quarter due to a slowdown in investments.  Gross domestic product (GDP) grew 4.1%, which was 40 bps short of analysts’ expectation, although GDP increased 0.5% sequentially. The growth rate also marked the lowest since late 2011. Investment grew 9.6% y/y, which was halved from growth of 18.1% experienced in the previous three months.  

iShares MSCI Chile Capped ETF (ECH) in Focus

Given this trend, investors should definitely pay close attention to ECH, the fund following the MSCI Chile Investable Market Index. This product holds 44 securities in total and charges investors 59 basis points a year in fees (see more in the Zacks ETF Center).

The ETF has amassed $515 million in its asset base since its introduction in November 2007. From a sector perspective, utilities (24.8%) and financials (17.1%) account for nearly 42% of the total, with consumer staples (13.6%) and materials (12.5%) making up double-digit allocations as well. With almost 60% allocation towards its top 10 holdings, the fund is exposed to higher concentration risk.

The ETF has slumped quite a bit from its lofty levels of early 2011 as it bore the direct impact of the global economic slowdown thanks to its extreme commodity focus. ECH got off to a decent start in 2013, returning around 1.3% in the quarter ending March 2013.

But most of its gains were lost in the beginning of the second quarter; as a result of which it lost around 10.4% year-to-date and 0.88% for the one-year period as of May 30, 2013. Some more short-term losses might stem after the lower-than-expected GDP data. The fund pays a decent yield of 1.47%.

Bottom Line

Despite all the downsides, we believe the longer-term outlook is relatively bright for this ETF. There are certain positives in this nation such as still-contained inflation, still-decent GDP rate on a nominal basis and buoyant retail sales, suggesting unwavering consumer confidence (read Andean ETFs: A Better Way to Play Emerging Markets?).

So for investors who believe that the Chilean economy is strong enough to battle the aforementioned issues, you can consider ECH an interesting pick. The country could rebound if China finds a bottom, and may pick up steam if the broader South American region returns to prominence later this year.

For these reasons, we currently have a Zacks ETF Rank of 2 or ‘Buy’ on ECH, so we are definitely looking for brighter days ahead for this fund as well.

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