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BIENVILLE MACRO REVIEW

Prepared by:

Mark Bower [email protected]

Cullen Thompson [email protected]

Emerging Markets: A Heterogeneous Approach July 19, 2013

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Bienville Macro Review – July 19, 2013 | 2

For nearly a decade, investors have steadily increased their allocations to emerging markets to tap into higher economic growth, rising commodity prices, and a weakening U.S. dollar. Expectations of a rising middle class and an eventual 'decoupling' of EM growth from the over-indebted developed world were pervasive. Commodity prices have weakened and the U.S. dollar has strengthened, challenging much of the original thesis for emerging markets. Recent performance across EM asset classes, including equities, credit and currencies, has been poor, led by the -9.7% YTD decline in the MSCI Emerging Markets Index. However, there are several exceptions that warrant a deeper look:

• Although there are many commonalities across the various emerging markets, there are also notable differences. For example, some are commodity producers, while others are importers, thus benefitting from lower prices. Also, while several emerging markets have witnessed a deterioration in their balance of payments, others remain solidly in surplus, and therefore are not reliant on external funding such as foreign capital flows

• It remains unclear whether investors fully comprehend the reflexive relationship between increasing commodity prices, which has been partly driven by China’s tenfold increase in fixed asset investment over the past decade, and emerging market fundamentals. This relationship is captured by correlations across asset classes

• As China’s growth rate continues to slow, the prices of many industrial metals have fallen. As a result, the growth rates of emerging markets tied to China have slowed

• Turkey and Brazil, two former darlings of the emerging market world, have slowed dramatically. They now both face difficult policy decisions as their interest rates rise and currencies sell off

• Many emerging market allocations have been funded in U.S. dollars—a quasi ‘carry trade.’ The prospect for higher interest rates combined with a broad based U.S. dollar rally leaves many emerging markets vulnerable to net capital outflows (i.e., capital repatriated back to the U.S.)

• At the highest risk are deficit countries reliant on external financing (e.g., Turkey, South Africa, Brazil). Several could face a balance of payments crisis. Others face a policy dilemma, as they have to balance the need to raise rates to prop up a falling currency, or keeping policy loose in order to support growth. As capital is repatriated, it creates potential balance of payments difficulties for external deficit countries

• Many countries with large external surpluses or liquid domestic financial systems are immune from these pressures and have managed to continue growing through 2013’s volatile environment for emerging markets

EMERGING MARKETS: A HETEROGENEOUS APPROACH

Summary

*This document is not a solicitation to invest in any investment product nor is it intended to provide investment advice. Please see the “Disclaimer” slide for information about Bienville Capital Management, LLC and for certain disclaimers relating to this presentation.


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Several important markets, such as China and Brazil, have led the index lower… However, many ‘surplus countries’, i.e., those markets which are not reliant on external financing, have performed well

Although the emerging market equity index is down approximately 10% YTD, there has been significant disparity between member countries…

-35% -25% -15% -5% 5% 15% 25% 35% 45% 55%

Peru

Brazil

Mongolia

Colombia

Czech Republic

Sri Lanka

China (HSCEI)

Chile

Poland

MSCI Emerging Markets

Bulgaria

Kenya

Kuwait

Nigeria

Pakistan

Abu Dhabi

Ghana

Dubai

Source: Bloomberg data, Bienville Capital Management

Emerging Market Equity Indices YTD Performance


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Emerging markets enjoyed almost a decade of outperformance versus developed markets, which began to shift in 2011. The unwinding of accumulated imbalances in EM should lead to further underperformance versus developed markets…

Emerging markets outperforming the S&P….

S&P outpacing EM….

MSCI Emerging Markets Index

S&P 500

From roughly 2001 to 2011, emerging market stocks substantially outperformed developed markets… Since 2011, the ratio has begun to trend lower. Given the deteriorating fundamentals in EM, we think that the ratio should continue lower This favors developed markets performing better than EM for the foreseeable future



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Emerging markets have a strong correlation with commodity prices…

The CRB index and emerging market stock prices have been correlated over past cycles since many emerging markets are commodity producers… Normalized to January 1997 = 100

CRB Index versus MSCI Emerging Markets

CRB Index

MSCI Emerging Markets Index



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Many emerging market currencies are also interrelated with the prices of their commodity exports. For example, the Chilean peso is highly correlated with copper…

Chile is the world’s largest copper producer and copper is estimated to account for 60% of Chile’s exports… Commodity weakness is negative for several other emerging market currencies with large commodity export earnings

Chilean Peso Rate

Copper, price per lb.


Copper Price Versus Chilean Peso


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Emerging markets display a strong correlation with Chinese growth…

Chinese growth is one of the major drivers of emerging market demand, and the continued slowdown in China does not augur well for emerging market equity prices


Chinese Industrial Production versus Emerging Market Equities


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Emerging markets also are related to Chinese current account trends. China is the world’s largest creditor—when it runs a large surplus, it reinvests the earnings in a host of foreign assets…

China’s current account surplus has been shrinking since 2009, giving it less capital to invest in other emerging markets


Chinese Current Account versus Emerging Market Equities


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In general, emerging market borrowing costs have increased substantially this year as bonds have sold off…

Emerging Market Bond Spreads

Emerging Market Debt Total Return, USD

Wider spreads created a significant capital loss


Emerging market debt in the second quarter suffered its worst drawdown in five years, in dollar terms. This was driven by three factors: 1. Higher U.S. Treasury

yields;

2. Higher credit spreads;

3. A stronger U.S. dollar against EM currencies

This has come during a time of only a modest widening in spreads Were spreads to widen as much as in past emerging market crises, investors would incur even further losses

Emerging Market Bond Spreads versus EM Bond Index Total Return


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Many large emerging markets have swung into current account deficits, which in many cases are larger than their pre-2008 levels. This has left them vulnerable to any shock, be it U.S. interest rates, global growth, or commodity prices…

Many emerging markets had imported capital on the back of developed world investors chasing higher yields High current account deficits constrain policy makers on how they can react to slowing growth, and can quickly lead to crises of confidence


Emerging Market Current Account Balances


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Many of these markets saw substantial currency sell-offs as a result of their high reliance on external funding in recent years…

A broad range of emerging market currencies are lower against the USD, between 5 and 15% Normalized to Jan 1, 2013 = 100


Emerging Market Currency Sell Off


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Current account deficit countries have seen declines in their equity markets this year, in addition to currency weakness…

While many of the surplus countries, defined as having a current account surplus, have experienced strong performance, they avoided the negative impact of higher U.S. rates and lower capital inflows. Most of these currencies are pegged or are in narrow bands versus the U.S. dollar…

Country

Current Account % of GDP

YTD Equity Market Performance (USD)

Saudi Arabia 24.4% 13.3%

Vietnam 7.4% 17.8%

Nigeria 6.6% 30.7%

Kuwait 45.0% 30.9%

United Arab Emirates (Dubai) 8.2% 50.8%

Country Current Account % of GDP YTD Equity Market Performance (USD) Currency

Performance

India -5.1% -1.9% -7.8%

Turkey -6.0% -8.5% -7.3%

Brazil -2.3% -29.0% -7.7%

South Africa -6.3% -13.9% -14.7%



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A look at one of the most prominent surplus country equity markets, Saudi Arabia, shows a strong rally this year…

Saudi Arabia runs large fiscal surpluses, and some of this excess liquidity has gone into the equity market… As a result, the market has been insulated from the political turmoil in the Middle East and sell-off in foreign markets


Tadawul Index YTD Performance


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By contrast, many major EM’s that are deficit countries have had a poor performance this year. A look at two of the most prominent emerging markets, Turkey and Brazil, shows similar patterns…

Deficit countries have been hit by the sell-off in EM currencies and EM debt.

Turkey Brazil


Brazil and Turkey Equity Index Performance


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Due to the currency weakness and rising developed world interest rates, short-term interest rates have risen dramatically in both Brazil and Turkey as in other deficit countries. This substantial tightening in monetary policy is coming at a time of economic weakness and should continue to put pressure on growth…

In past cycles, EM central banks were able to ease monetary policy as they faced weaker economic growth. In this recent cycle, however, they have been forced to raise interest rates to stem capital outflows Interest rates have not moved this year in Saudi Arabia, as the country’s financial system is amply funded

Brazil 3-Month Swap Rate

Turkey 3-Month Govt. Bill Yield


Saudi Arabia 3-month Interbank Rate

Rising Emerging Market Short-Term Interest Rates

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Disclaimer

The Bienville Macro Review (the “Presentation”) is a distribution which highlights the research of Bienville Capital Management, LLC (“Bienville”) in different areas of interest across the macro landscape. Bienville believes that understanding the global macroeconomic backdrop is a prerequisite to efficiently allocating capital.

The Presentation is not intended to be an all-encompassing review of the financial markets. Rather, it should serve as a concise summary, which provides clients with an update of Bienville’s areas of focus within its research process. We hope that the Presentation will create an ongoing dialogue with our investors on the global dynamics that drive the financial markets. The topics covered in the Presentation may or may not be related to Bienville’s active positions or investment strategies.

The content of the Presentation includes forward-looking statements, estimates, projections, assumptions, beliefs and opinions (collectively, “Projections”), which may prove to be substantially inaccurate or based upon flawed reasoning and assumptions. Moreover, Projections are inherently subject to significant risks and uncertainties beyond the control of Bienville and its affiliates, including Bienville Capital Partners, LP, Bienville Capital Partners Offshore, Ltd. and Gulf Coast Opportunities Fund, LP (and collectively with other private investment funds that Bienville or its affiliates may form and manage in the future, the “Funds”).

The information contained in the Presentation regarding Bienville and the Funds has been prepared solely for illustration and discussion purposes. Except where otherwise indicated, the Presentation speaks as of the date hereof, and Bienville undertakes no obligation to correct, update, or revise the Presentation, or to otherwise provide any additional materials. Although Bienville believes the Presentation is substantially accurate in all material respects and does not omit to state material facts necessary to make the statements herein not misleading, Bienville makes no representation or warranty, express or implied, as to the accuracy or completeness of the Presentation or any other written or oral communication it makes with respect to the tactical positions or investment strategies described herein. Bienville expressly disclaims any liability relating to the Presentation or such communications (or any inaccuracies or omissions herein). The Presentation merely constitutes an opinion or belief based upon the information set forth herein, which opinion or beliefs may prove to be wrong. The information and opinions contained in the Presentation are based on public information.

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