Insights & Advice

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Commodities and Emerging Markets

It has been a given that where commodities go so goes emerging markets, however, that correlation seems to have broken down over the last few months. While commodities, both precious and base, have continued to rise, emerging markets have underperformed since November. What gives?

For several years the basic investment thesis is that emerging markets are economic juggernauts with an insatiable demand for the world’s natural resources. Their factories devour every form of commodity and transform them into the world’s textiles, steel, clothes, cars, toys, electronics and scores of other exports.

But sometimes you can come up against too much of a good thing. That is what is happening to several of the larger emerging market countries such as China, Brazil and India. All three countries managed to avoid global recession. While we languished with high unemployment and negative growth, most emerging markets continued to grow and grow and grow. As a result, their domestic economies are beginning to overheat.

As they do, their inflation rates are starting to rise to uncomfortable levels with serious consequences for their economic future. China, for example, grew 9.8% in the fourth quarter while registering a 4.6% inflation rate. This week Brazil announced that consumer prices in their country rose to nearly 6%.

The governments of these countries have responded by raising interest rates and tightening credit conditions. The Brazilian Central Bank hiked interest rates by one half percent to 11.25% on Thursday and observers expect another hike very soon.

Local investors, drunk on ever-higher stock prices in 2010, are decidedly miffed that their central banks are taking away the punch bowl this year. China’s stock market has declined over 15% since November. Brazil and India have also underperformed the U.S. markets as well.

In the meantime, commodity prices have largely ignored this new reality until very recently. Brazil’s sudden rate hike, in combination with China’s higher reading on domestic inflation this week, have finally shaken some of the euphoria out of the commodity market. We need this pullback (and I hope it continues) in order to square prices with reality in the emerging markets.

I believe the declines in emerging stock markets are coming to an end. I would be a buyer of those markets on further pullbacks, because I still believe that regardless of any further short-term actions to slow growth, their economies will still outgrow more developed markets this year, next year, and the years after that. Commodities are also a great place to invest once this pullback is over. I advise that you wait for some price stability before adding to positions.

As for the U.S. stock markets, it appears that just about everyone is now in the “too extended, probable sell-off” camp that we have been waiting for over the last few weeks. The contrarian in me doesn’t like to see the consensus come over to my point of view because the stock market often does what is most inconvenient to the greatest number of people.

Nonetheless, I would love to see a 3-5% correction before the end of the month. It would give me the opportunity to put more money to work. For specific recommendations, call or e-mail me.

Posted in A Few Dollars More, At the Market