METALS ARE TRUMPING

Marxism as the No. 1 reason to avoid investing in Latin America right now.

Most of the focus on the region has been on the growing political trend that's put left-leaning leaders at the heads of many Latin American countries, including Luiz In cio "Lula" da Silva in Brazil and fiery rhetorician and avowed George Bush hater Hugo Chavez in Venezuela. It's become more acute lately since elections are looming this year in Brazil and Mexico.

Those two countries are the region's largest economies and typically make up the vast majority of any emerging-market portfolio focused on this hemisphere. In fact, about 80% of a Latin American fund's assets are invested in those countries, making them more like country-specific funds. Mexico goes to the polls July 2, while Brazil votes on Oct. 1. The votes mark a stage in the region's development of multiparty democracy if Lula, whose administration is mired in a finance scandal, wins another six-year term or if Andr s Manuel L pez Obrador, the former mayor of Mexico City, retains a shrinking polling lead over Felipe Calderon, of President Vicente Fox's National Action Party.

From a political landscape, the fear is that more left-wing rule will lead to economic disarray. Indeed, recent developments in Bolivia should give investors pause. New president Evo Morales this week announced the nationalization of the country's oil and gas reserves, and he issued an ultimatum that foreign companies must negotiate new contracts with the government that would send all oil and gas revenues through Bolivia's state-owned oil company, or leave the landlocked Andean nation. Reports said new contract terms haven't been publicized, but would presumably give Bolivia a higher percentage of those revenues. Its daily oil output is only 40,000 barrels, but the country has sizable gas reserves. About half of its gas production goes to Brazil.

But, while reading the political tea leaves can be useful, many investors should consider scaling back for a more mundane economic reason: The region may be overvalued.

Politics is important, but the conventional wisdom about how these left-leaning governments would addle economic growth hasn't come true. Remember, the worst-case scenario was that Lula's rise in Brazil would create an upheaval in that country similar to the one brewing in Bolivia, and didn't happen.

"I don't think you can completely avoid the political risk, and it still needs to be monitored," says Robin King, an economist at the Center for Latin American Studies School of Foreign Service at Georgetown University in Washington, D.C. "But the surprise of Lula, say, playing by international rules can be attributed to the dependence Brazil has on global capital markets. In markets like Brazil and Mexico, to a lesser extent, there's a feeling that if you want to be an international player down the line, there are rules you can't afford to ignore. You need to learn to live within them."

For investors, the bigger concern should be fund and stock prices, which have become more expensive over the past few years and raise the specter that the best investment days for the region are behind it for now. According to investment-research company Morningstar, Fidelity Latin America, Merrill Lynch Latin America I, and DWS Latin America Equity were among top-performing mutual funds in 2005. As a group, Latin American funds climbed more than 60% in 2003, about 40% in 2004, and finished 2005 up 54%.

"Latin American funds have been doing great and people should not be thinking about buying them," says Morningstar analyst Bill Rocco. "Anyone who looks at one and says, 'Boy, wouldn't it be great if it went up another 85% next year,' is just looking for trouble. There's no telling when the party's going to end."

The world-wide surge in commodity prices is a major reason for huge gains in the indicators used to measure the region's performance for equity investors. The S&P Latin America 40 index is up 20.2% since Jan. 3, sustaining a nearly uninterrupted climb that began in late 2002. Looking at the makeup of the S&P Latin America 40 stock index as a rough guide for what's working in the region, it's clear that resources are its greatest source of growth. Its component stocks include robust performers such as Brazilian paper maker Aracruz, Banco Santander Chile, and runaway names such as mining giant Companhia Vale do Rio Doce and energy behemoth Petroleo Brasileiro.

By May 1, when the index was up 23.2% for the year to date, energy stocks were up 47.1%, while materials stocks, including commodities, were up 26%. Financial-sector stocks were also solid contributors, up 27.2%.

Those gains are reason to stay away for investors who haven't yet dabbled in Latin America. For those already in the region, commodity prices will likely be the best gauge of when to get out. "If commodity prices were to take a downward turn, all the economies that are dependent on them will take a significant hit and assets would fall accordingly," says Christopher Garman, Latin America analyst for Eurasia Group, a political-risk consulting firm, in New York.

Finding that peak is easier said than done. In a hot commodities market, it's tough to tell when that point is reached. Copper and nickel prices hit record 17-year highs in late April, as aluminum, lead and zinc prices increased as well, then took a little dip.

None of this is to say that the rest of the world, or even emerging markets, aren't worth a portion of the average portfolio. But Morningstar's Rocco says a broad-based international fund strategy should suffice for most small investors, with a little variation for those with higher risk tolerance.

"Most U.S. investors have only had one international fund," he says. "Now they have two. The first should be a core international fund of large caps in large markets. Most of those funds have about 10% in emerging markets, including Brazil and Mexico. Then you can have a supplemental holding it might not be a bad idea to get a foreign smaller-cap fund or an emerging-market fund."

Just avoid funds aimed exclusively at Latin America. "They're somewhat akin to owning a single-country fund," Rocco says. "If you want to make a stock-like investment, not one that's helping you build a solid portfolio, and your aunt Gertrude dies and leaves you $20,000, and your kids' college fund is all paid for, then you can say, 'I'm not buying a tech stock, I'm buying a Latin American fund or a China fund.'"