Beware a Mexican Hangover

This column was originally published on RealMoney on May 3 at 1:13 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

I went to college in San Diego, and every spring break we went to Mexico, and we always had fun there. However, every year something bad would happen -- be it a broken leg or a new Ford Bronco getting stuck during low tide, and staying stuck when the tide came in. (I'm sure the fact that we were rowdy college students had nothing to do with either episode.)

Investors in Mexico have had similar ups and downs.

In 1992, the benchmark IPC went from 1900 to below 1300 in just four months, and the IPC was cut in half in 1994 in the face of the now-distant peso crisis.

But there have been some spectacular growth periods, too. The IPC is up 250% over the last five years, while the S&P 500 is, are you ready, a whopping net unchanged. But during this five-year IPC rally, there have been some big corrections, including a 26% decline in 2002 and a couple of other 10% to 15% declines.

So what's driving Mexico? There are a couple of themes to this emerging market, starting with its abundance of natural resources. The U.S. gets roughly 16% of its oil from Mexico, and the country also has copper, silver and zinc.

Oil is very important to Mexico, so the commodity's high price is a huge boon to the country. But there are also risks, as it is an emerging market.

Oil production in Mexico has declined of late, and progress on new exploration has been moving very slowly. If the stock market starts to worry about production rates, a correction could be swift and severe.

Another risk is political. The country has a presidential election set for July 2, and former Mexico City Mayor Andres Manuel Lopez Obrador has led the polls for months, although it was reported late last week that he has lost his lead.

The risk created by a prospective Obrador presidency is that he has been likened to Hugo Chavez, and there is some concern about just how far to the left he leans. It would appear that skipping a presidential debate and the Chavez comparisons are what led to his poll numbers slipping, but he is by no means out of the race.

The IPC vs. the S&P 500

Source: Your Source Financial

There is no way to fully dissect all of the complexities of an emerging market in just one column, especially a market that is perhaps on the verge of a major transition. But for those investors willing to brave these risks and bet that Mexico can reverse the oil-production trend and not elect a Chavez ally, it is a very accessible country.

There is one ETF, the iShares MSCI Mexico (EWW), two closed-end funds -- The Mexico Fund (MXF) and The Mexico Equity and Income Fund (MXE) -- and 19 NYSE-listed ADRs, according to The Bank of New York.

For now, the economy is doing well, as the central bank estimates GDP growth for 2006 will be 3.5% to 4%. According to Jyske Bank, a Danish bank whose commentary I follow closely, 10-year bond spreads have been narrowing vs. U.S. 10-year Treasuries, which is usually a sign of confidence.

The IPC Index is up 16% this year, compared to just 5% for the S&P 500, and the trend appears to still be strong. It seems the capital markets have not yet priced in the concerns raised here, so I am either wrong or early.

But if you're trying to select which emerging-market countries to invest in, there are plenty of resource-rich markets to choose from with risks that aren't so tangible.

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Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. At the time of publication, Nusbaum had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.