Beware of the Resource Curse of Boom and Bust Cycles

Brazil rode high during its commodity boom and has been licking its wounds ever since. Venezuela bought friends in the Caribbean with discounted oil and now its citizens cannot find milk, diapers or toilet paper in the stores. Beware of the resource curse of boom and bust cycles in commodity dependent economies. Bloomberg writes about the economic meltdown in one resource rich economy, Mongolia.

Mongolia, a mineral-rich and landlocked $12 billion economy bordering Russia and China, is staring at a full-blown balance of payments crisis. It’s caused barely a ripple in global financial markets, but the nation’s economic meltdown offers instructive lessons to far bigger resource-reliant economies like Brazil, Venezuela, Russia and Saudi Arabia.

An overabundance of natural resources can result in lopsided economic growth, government waste and boom-bust cycles that can leave a country’s finances in tatters.

Perhaps you have engaged in foreign direct investment in countries like Mongolia, Brazil, Russia or Saudi Arabia or have bought into stocks of companies that invest in these places. If that is the case you need to beware of what the economists call the resource curse of boom and bust cycles. Mongolia, like other resource rich countries, rode the Chinese economic boom to the top and then started to use their cash flow to get or issue credit to build too fast and syphon off their riches just as the riches were on the downturn. Investing in these countries can be profitable but how do you proceed in order to avoid losses? Our direct foreign investment article provides a few clues.

Foreign direct investment is done by folks with lots of money and the intention to stay a course and make a profit. If you are looking for offshore investment ideas, take a look at where foreign direct investment goes year after year after year. There have been changes afoot regarding where foreign direct investment is going. A very useful reference in this regard is the just published United Nations study, World Investment Report 2013. We have used 2007 and 2012 as bookend comparison years as 2007 was just before the onset of the worst recession in three quarters of a century and 2012 is the most recent year reported. Of note is that direct foreign investment has fallen in the large majority of nations but there are exceptions that should help guide investors with their fundamental analysis of where to put their money in the years ahead.

Take a look at the more recent World Investment Report of the United Nations for information as to where the smart money is going. Then you can pursue investment in commodity rich countries and often pick up bargains when the nation is going through the bust phase of their economic cycle. After all, the world always needs raw materials and the world economy always cycles up and down. Just don’t buy in at the top of a commodity boom only to lose your money in the bust. Beware the resource curse when investing.

Beware of the Resource Curse of Boom and Bust Cycles PPT

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