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The fundamentals are improving in Brazil–but right now it’s global cash flows that are driving emerging market stocks.

In the long run I want Brazil in my portfolio because of those improving fundamentals . In the short run I want to own Brazilian stocks because global cash is flowing their way. In the intermediate term, though, say nine months from now I want to get increasingly cautious as the U.S. Federal Reserve moves toward raising U.S. interest rates.

Right now all that adds up to a new higher target price for Market Vectors  Brazil Small Cap ETF (BRF).

First, the fundamentals. On October 14 Goldman Sachs economist Jim O’Neill said that with the right mix of policies Brazil could sustain average annual economic growth of 5% over the next ten years. That’s a step up from Goldman’s prior projections of 4% to 4.5% growth and a huge jump from the days when Brazil struggled to get annual growth of 3% and badly lagged India and China.

O’Neill gives full credit for the improvement in growth to current Brazilian President Luiz Inacio Lula da Silva,  Known in Brazil as Lula, the president has built a foundation of low inflation and sound fiscal policy that has released a tide of investment in Brazil. Lula cannot run for a third four-year term so it will be up to the winner in next year’s election to continue those policies.

Second, global cash flows. In my end of the day post on October 14 I explained how the U.S. dollar carry trade is pushing up global asset prices. (In short traders can borrow dollars really cheaply right now, invest them in assets such as commodities or emerging stock markets, and then repay them in cheaper dollars thanks to the continued decline of the dollar.)

I also listed the eventual unwinding of this trade as one of  my worries for, say, mid to late 2010. The dollar will at least threaten to rally when the Federal Reserve starts to raise interest rates. And that will pull money out of currently favored assets as traders move to pay back their loans.

But mid-2010 is a long way off and it’s not even clear if the economy will be strong enough by then so that Federal Reserve will actually be able to raise interest rates.

So in the near-term, I think I’m going to hold onto my position in the Market Vectors  Brazil Small Cap ETF and up my target price.

(You’ll remember from my initial buy that I picked this ETF over the much larger iShares MSCI Brazil Index ETF (EWZ) because the Market Vectors ETF is weighted toward small and medium size companies in Brazil’s domestic consumer sector while the iShares ETF is weighted toward Brazil’s commodities and export giants.)

As of October 15 I’m raising my target price on the Market Vectors  Brazil ETF to $51 by June 2010 from the prior target of $44 by that date.

(Full disclosure: I own shares of iShares MSCI Brazil Index ETF and Market Vectors Brazil Small-Cap ETF in my personal portfolio.)