Argentina: Opportunity Lost?

On the surface, it would appear Argentina offers plenty of potential for investors. The second-largest South American economy behind Brazil is also home to, by some estimates, the third-largest shale gas reserves in the world. Gross domestic product there grew at an average rate of 7.1% per year from 2003 to 2011. Those statistics might be enough to send unknowing investors into Argentine stocks or the Global X FTSE Argentina 20 ETF ARGT, the lone ETF tracking Argentina. Argentina, is designated index provider MSCI MSCI as a frontier market, a label which implies a higher degree of risk relative to emerging markets. As is the case with so many emerging markets, Argentina has a dark side. That dark side, which has punished the Global X FTSE Argentina 20 ETF, cannot be ignored. The country's problems literally come from the top, meaning President Cristina Fernandez's policies present major risks to investors and significant hurdles to her country's economy. That much was highlighted earlier this year when the Argentine government moved to nationalize energy firm YPF S.A. YPF, a move that pummeled ARGT and led to elevated yields on Argentine debt as well as a surge in the prices of credit default swaps to insure that debt against default. Now, Argentina's economy is faltering due in large part to government policies thar are viewed as unpredictable and inhospitable to foreign investment. Analysts predict Argentina's economy will grow 2.5 percent to 3 percent this year, according to the Associated Press. That comes after first-quarter GDP growth of 5.2 percent. More alarming is the fact that the central bank is forecasting growth of 6 percent and the government's budget said 5.1 percent growth is to be expected. The potential discrepancy between government estimates and reality would only lend fuel to the argument that the Hernandez administration is less than trustworthy. "Argentina is a basket case and is in need of substantial economic, political and social reform," said Colombia-based independent analyst Caiman Valores. That perception is now reality and it could spell bad news for Argentina's economy in the future. Some of the largest oil companies in the world, including Chevron CVX, have done business in Argentina. However, the nationalization of YPF can be interpreted by U.S. and European energy firms as a hostile act and one that says the government does not want Western investment. Argentina is also rich in mineral resources and while the country's mining industry is less regulated than its oil business, there is still an export tax of 10% levied on Argentine mineral exports, again creating an additional cost for mining companies operating there, according to Valores. "The political risk is extremely high and the overall country risk is extremely high," he said. Valores notes that on a one to 10 risk rating for investors, with 10 being most risky, he would give Argentina a nine. The impact of Argentina's politics on ARGT has been palpable. When news of the YPF nationalization first broke, the ETF had $3.5 million in assets under management. That total had fallen to $2.8 million as of June 20. The materials and energy sectors combine for almost 42 percent of ARGT's weight, making the fund vulnerable to any future efforts by Fernandez to further nationalize those sectors. Said another way, it is not surprising ARGT has plunged almost 27 percent in the past three months. That performance belies the fact that ARGT is actually home to some decent and familiar stocks. Take Pan American Silver PAAS, Silver Standard Resources SSRI and Yamana Gold AUY. That trio combines for 12 percent of ARGT's weight. In the past month, Yamana is the worst performer with a gain of 17 percent. Over the same time, ARGT is up just 2.3 percent, further proof this ETF is being hamstrung by Argentina's unfavorable regulatory climate. The bad news does not end there. In its annual market reclassification unveiled on Wednesday, MSCI noted Argentina could be removed from the MSCI Frontier Markets Index. "MSCI continues to monitor closely the situation in Argentina following the nationalization of YPF through the “expropriation” of a 51% stake from the Spanish company Repsol by the Argentinean government," the index provider said in a statement. "Any further such government intervention in the “free‐market” economic system may force MSCI to launch a public consultation with the investment community on a potential exclusion of the MSCI Argentina Index from the MSCI Frontier Markets Index." ARGT does not track the MSCI Argentina Index, but the loss of that index' frontier markets status could bring about more black clouds for the ETF. There are glimmers of hope, though. At less than $8, investors with a high tolerance for risk can treat ARGT as a no-expiration call option on a dramatic improvement in Argentina's political climate sometime in the future. "There are high-potential investment opportunities for speculative and canny investors," Valores said. "Especially those that are willing to ride the boom/bust cycle the Argentine economy operates in." For more on Argentine stocks, click here.