A bold investment that might just pay off

Iceland is on the mend. Thanks to its abundant natural resources, the country is once more attracting investment, says Matthew Partridge. Here's how you could profit.

This nation has vast reserves of energy; it's at the centre of an international dispute; one of its former leaders has recently been tried in court for actions taken during his reign; and the stock market is down 90% from its peak.

Is this one of the Soviet Republics? An Arab Spring' participant? Somewhere in Africa?

Nope. It's Iceland. And it may be one of the best if riskiest investment opportunities out there right now.

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Iceland said no to the bankers

We've alreadycovered the Icelandic story insome detail. Here's the short version: in the five years to 2008, Iceland's banks went wild, buying up huge amounts of assets. The population followed suit.

Naturally, the banks ended up going bust. But unlike bust banks almost everywhere else in the world, the Icelandic ones didn't get bailed out. Instead, Iceland only protected domestic depositors.

This decimated the stock market and the Icelandic krona. It also made the British and Dutch angry since they had to pay off their own savers who had put money into Icelandic banks, tempted by suspiciously high interest rates.

However, it did also mean that Iceland avoided defaulting on its debt technically at least. While inflation destroyed consumers' purchasing power, it also meant that labour costs adjusted quickly, so unemployment remained relatively low, and growth recovered more quickly.

And Icelandic civil society remains intact, for all the blood-curdling warnings we received about what would happen if banks went bust.

Because of this, we're not huge fans of the decision to try former leader Geir Haarde.

However, experts believe that themain aim of the trial (which ended last month, with a verdict expected soon) is to make public more documents from during the period. Iceland has not suddenly become a banana republic.

Of course, it's not in shipshape condition yet. The government continues to run a deficit of 4.4% of GDP (ie, that's how much it's overspending each year compared to tax revenue). However, if you exclude interest payments, the primary deficit is a tiny 0.5% of GDP. And Iceland has managed to cut spending from 51% of GDP in 2010 to 46.1% in 2011. This shows that the political will for a balanced budget exists.

Indeed, ratings agency Fitch has praised Iceland's consolidation as "robust". It thinks that the headline deficit should turn into a surplus by 2014. Fitch also predicts that "barring further shocks, Iceland should see a sustained reduction in its public debt/GDP ratio from 2012".

Iceland's advantage in natural resources

Iceland is also sitting on vast assets in the form of natural resources. Geothermal and volcanic resources mean that the tiny nation has a great deal of cheap power. Until now, it has been very difficult to export this directly. However, it is working on two plans both involving undersea cables.

The first plan would involve connecting Iceland with northern Europe's energy grid. This would allow it to sell its cheap energy to Britain, Holland, Norway and Germany. A study last year found this idea to "be worthwhile today, or within a few years".

The second idea, which should be finished later this year, is to build a high-speed internet connection to Ireland. This would cut the time that it takes to send data from Europe to America. It is also hoped that it would encourage data centres (where the vast quantities of digital informationnow collected on a daily basis are kept) to locate in Iceland. Data servers work best under cold temperatures, and require lots of energy. This makes Iceland ideal for the purpose.

At the same time, Iceland's fishing industry is poised to benefit from higher prices. As my colleague James McKeigue has pointed out, the World Bank fears that there could be a fish shortage. This could push prices higher. However, Iceland's quota system has allowed it to conserve stocks.

How to invest in Iceland

It is not easy to bet on a continued Icelandic recovery. The collapse of the stock market meant that the only UK-based fund directly geared to Icelandic shares was wound up. Iceland's small size means that no spread-betting firm covers the krona.

However, all is not lost. It is possible for non-citizens to open an account with one of the major banks. You can then use the funds to invest in a government or stock-market fund.

If you want to go down this route, then the best option is Arion Bank. This bank was formed from the ruins of Kaupthing, which went bust. It is free from the debt problems of its predecessor. It offers a wide range of reasonably priced accounts and funds. Two possible options are the Stefnir Icelandic Growth Equity Fund and the Stefnir Treasury Note Fund. Savings accounts with the bank are backed by the state TIF fund, which means if the bank goes under, you will be compensated.

Some capital controls remain. However, they are targeted at those holding large amounts of Icelandic krona in offshore accounts. Retail investors in stock and bond funds are able to sell their investment, close the account and withdraw the capital as and when they wish.

An easier-to-access (though still risky) option, is Wasabi Energy (LSE: WAS). It has developed a new technological process that makes geothermal energy more efficient. To take advantage of this, it bought the Husavik Kalina plant in Iceland last year. This means that it will make money from selling energy to Icelandic households. However, it also puts Wasabi in a prime position if Iceland is ever connected to the European grid.

The firm's main operations are in Australia. However, while the wider economy will be hit by a Chinese hard landing, Wasabi's anti-evaporation technology and biofuel arms should be recession-resistant. The chairman, John Byrne, has previously turned small mining and energy firms into huge companies.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri