A smart play on falling copper prices

Chile stands out from the other Latin American countries.Many of them have huge natural resources, but what sets Chile apart is the way it manages its resources responsibly. In Chile, mineral wealth has driven the economy forward over the past three decades, and made the people better off.

During the last quarter of the century, GDP grew at an average 5.5% per year an incredible record that has put it within touching distance of developed world status.

For a country that's become used to economic success, the slowdown is hard to take. Meanwhile, regular New World readers will know that Chile, along with the other Pacific Alliance countries, is one of my favourite economies in the region.

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But I'm not about to hit the panic button just yet. In fact, I think the slowdown will be good news for my longest-running Chilean tip.

What's gone wrong?

A lot of developing countries fall foul of something called the resource curse'. The resource curse describes how developing countries with a lot of natural resources tend to end up poorer than developing countries which don't have them.

It's speculated that politics is the main reason that the money from natural resource exports rots' developing countries' governments, making them more corrupt, which slows down their countries' growth.

Chile avoided the resource curse despite having the world's largest reserves of copper. That says a lot about the country. In a continent where corruption and bad governance is normal, Chile's government stands apart.

Moreover it's also tried hard to use the money from copper to diversify its economy and invest in other areas. Agriculture is a huge business here, and Chile has become the world's second-biggest salmon exporter, and its fifth biggest wine exporter.

The economic boom has also helped to create retail giants: listed firms such as Cencosud and La Polar that are now spreading out across the region. Finance is another strong area where local banks and funds have sprung up to make Santiago an emerging regional hub for financial services.

All in all, copper accounts for just' half of Chilean exports, down from two-thirds in 1973. But while it's made progress, it's clear that Chile's fortunes are still very much tied to copper. As a result, the Chilean economy has been hit by the fall in the copper price, which has slid by around 25% in the last few years.

So how serious is this?

That's the question I put to Chile's minister of the economy, Luis Felipe Cspedes, when I interviewed him in Santiago last month. "What we are experiencing now is a cyclical deceleration", says Cspedes.

"Between 2010 and 2013 we had a significant increase in investment, which was being driven by high commodity prices and the resultant increase in mining projects. Moreover international finance conditions were very attractive, which made it easy to issue debt abroad and there was lots of liquidity. So while all of these factors were giving additional stimulus to our economy then we knew, before coming in March, that the economy was facing a cyclical slowdown."

Now, I need to add a bit of a political disclaimer here. A lot of people in Chile are putting at least some of the blame for the slowdown on the new government. The left-wing administration came to power promising a huge tax overhaul that would raise an extra 3% of GDP by taxing companies and the rich.

And, so the argument goes, the uncertainty and debate about this reform has led to businesses delaying their investments. So, Cspedes has a vested interest in describing the current slowdown as a cyclical problem that started before his government.

Nevertheless what he said next really struck a chord with me: "The good news is that we have all the tools to provide a stimulus if necessary. So, with monetary policy, we have seen rates come down from 5% in 2013 to 3.75% at present. If needed it can come down more, so we have a monetary policy that can help further. That reduction in the interest rate is causing the peso to depreciate which helps export sectors in economy."

Why did that interest me so much? Because back in August 2012, when I gave my first ever Chile tip for MoneyWeek,I said that Chilean winemaker Via Concha y Toro (NYSE: VCO) would be a handy hedge against falling copper prices.

Since my tip, the Chilean peso has depreciated by about 20% against the pound, dollar and euro, but the share hasn't done much it's up by just 4%. Part of the reason for this is that it takes time for the exchange-rate effect to filter through to the firm's costs.

Fortunately, now there are signs that this is starting to happen. VCO's second quarterresults were out last week and they made for impressive reading. Over the first six months of 2014, sales were up by 27% compared to the same time last year.

Meanwhile, Ebitda is up by 106% over the same period. The firm is under no illusions about what's happening, listing the exchange rate as one of the most important factors behind the increase in Ebitda.

You can read the full investment case for VCO in my original article. But with the Chilean peso unlikely to recover anytime soon, I think that the firm will continue to benefit. And that should eventually start to be reflected in the share price.