This Peru boom will run and run

published 10 June 2013

The signs of Peru's economic growth are everywhere at the moment. At a lunch this weekend a Peruvian friend who lives over here was telling me about how life is changing for her family back home. "Before, practically none of them had left Peru. Now, when they want to relax they go to New York for a long weekend."

The reason for the fancy holidays? Mining. Her brothers work in the sector and enjoy a bonus of 21-times annual salary. Mining is also changing the nature of Peruvian city life, making it more cosmopolitan. She joked that her British husband, whom she'd met when he worked in one of Peru's provincial capitals, would be less of a novelty to local women these days.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Of course Peru is no stranger to bubbles. As respected Latin American-focused economic historian Victor Bulmer Thomas notes, Peru has a long history of economic "bonanzas". In fact, in the modern economic history of Peru this is the fourth bonanza. The country that has lived through the guano boom, the rubber boom and the fishmeal boom, now seems to be enjoying the fruits of the metals and minerals boom.

Peru's first modern economic boom came about halfway through the 19th century. Before the boom the newly-independent country was in a terrible way, having run up huge debts to finance its war against the Spanish. Peru won but victory meant Lima lost its status as the Pacific capital of Spain's Latin American empire. And when what used to be called "upper Peru" broke off as Bolivia, and took the lucrative silver mines with it, the Peruvian economy was left with nothing. Nothing that is, apart from bird poo.

The pre-colonial indigenous population had long used excrement from the guano birds, which piled up in large volumes in their island nests, to fertilise their crops. But when the Spanish came, guano was largely forgotten, as they were more interested in the region's gold and silver. However, by the mid 19th century, Europe was undergoing a massive population explosion and needed fertiliser to boost agricultural potential. Pretty soon enterprising British businessmen had won concessions to collect and sell the guano to Europe.

Guano magnates, like Bristol-based William Gibbs, became extraordinarily rich, while Lima recovered its former glory. Yet even in the midst of the boom there were signs that trouble was brewing. For starters, despite the fact that the guano trade was meant to help Peru pay off its loans, the country's debt was increasing. That was partly due to the unfair payment system organised by London traders, but it was also down to growing largesse and waste in the Peruvian government. Buoyed by the guano revenue, which by 1860 provided about three quarters of its income, the government began to plan ever more ambitious programmes. To finance these it needed more capital and issued increasing amounts of debt in London, eventually becoming one of the biggest borrowers in the European capital markets.

Other factors were also starting to hit the guano trade. In many ways it was a victim of its own success as the high price encouraged farmers to explore alternatives such as nitrate fertilisers. Moreover the rapid, poorly conserved extraction of guano meant that resources were becoming depleted. This problem was exacerbated by brutal extraction methods that scared off birds and discouraged them from nesting. The final straw came when the Pacific War broke out between Peru and Bolivia on one side and Chile on the other. Chile temporarily seized Peru's guano islands and even entered Lima. The four-year war proved the brutal end of the Guano age and left Peru in a worse condition than when it began.

Over the next century Peru enjoyed' two similar booms. The first was a rubber and petroleum boom that came to a crashing halt in the wake of the Great Depression. The second was a boom in fishmeal production instead of waiting for the guano birds to eat the fish and turn it into feedstock, Peruvian companies used modern trawlers to turn the fish directly into fishmeal that could be fed to animals.

All of these boom periods had several shared traits. They were all based on extracting Peru's natural resources. They were all developed by demand in the leading economic power of the day. For example, the guano and rubber booms were linked to the British economy, while the fishmeal boom was an American affair. They were also all managed badly, leading to resource depletion or environmental damage. And most of them were undermined by domestic or regional political instability.

But perhaps most important of all, the booms failed from a fiscal perspective, never leaving the country any better off than it was before. Indeed, apart from the odd success story for example Gibbs & Son sold out of the guano trade at the height of the boom in 1861 and the country pile he built with the money, Tyntesfield House, stands to this day many, especially locals, did poorly out of the booms.

So are we seeing a repeat with Peru's current metal and minerals boom? There are definitely a lot of similarities. Again Peru's prosperity is based on extracting natural resources and selling them abroad. Again it finds itself selling to the world's dominant power so invariably the relationship means more to Peru than its partner. Although this time China has taken the position formerly held by Britain and the US.

But while the similarities may be striking there are also many positive differences. One is politics. Peru's relationship with its neighbours is far more stable now. Chile is now a fellow member of the Pacific Alliance and their disagreements about contested land now take place in the international courts rather than the battlefield. On the domestic front, President Humala has his faults he is generally criticised for being indecisive and poorly managing conflict with local community groups about mining projects. Yet he runs a far more efficient, honest administration than any government in the previous booms.

Even the environmental protests that hold up new mining projects are a positive improvement on previous booms, where wanton brutal extraction left long-term environmental destruction. It is also slowing the rate of increased production, which may not be a bad thing given that previous booms undermined themselves by flooding the global market. Meanwhile the threat of substitutes, such as the sodium nitrate fertiliser that replaced guano and the synthetic rubber that doomed natural latex, still seems far off for the gold, silver, oil, gas and copper of Peru's boom du jour.

But the most important difference of all is diversification. Don't get me wrong Peru is heavily dependent on commodities, which account for around 75% of exports, but it's taking big steps to diversify. Since 2002, the value of the agriculture sector has grown by around 45% and it now accounts for almost 8% of GDP. Meanwhile, the commodity wealth has been reinvested in massive infrastructure programmes, with construction now a major driver of the economy. As I've mentioned before, these building programmes will help other sectors by making the country's companies more competitive.

So what's the best way to play this trend? One of my long-term favourites is Peruvian cement producer, Cementos Pacasmayo (US:CPAC). Based in the country's less-developed north it has direct exposure to the type of infrastructure projects that Humala is so keen to bring to the communities. Moreover, in echoes of the Guano Age, it also owns large phosphate deposits that it hopes to turn into fertiliser. If successful this project would give another boost to the shares.

James graduated from Keele University with a BA (Hons) in English literature and history, and has a certificate in journalism from the NCTJ. James has worked as a freelance journalist in various Latin American countries.He also had a spell at ITV, as welll as wring for Television Business International and covering the European equity markets for the Forbes.com London bureau. James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.