EMs Are Leading Producers, Consumers of Raw Material

Many of the world’s largest emerging markets are leading producers and consumers of raw materials. As a result, their business cycles tend to be highly dependent on fluctuations in the global prices of commodities.

For example, Brazil has an abundance of natural resources. It is one of the top producers of agricultural products, has large reserves of crude oil in offshore basins off the Atlantic Ocean and substantial iron ore resources, Coutts.com reported.

Meanwhile, China–and to a lesser extent India–has surged as an importer of commodities over the past two decades to fuel economic growth. In 1990 China accounted for only 2% of all commodities traded, while the US and Japan accounted for about 15% each. By 2013, China was the leading commodity importer with 15% of global trade, while the US and Japan had fallen to 10% each.

China’s stellar growth in recent years was shared by many emerging economies as they provided the exports to sustain its surge. Yet these same economies have also been affected by China’s periods of slower growth. Indeed, the decline in commodity prices over the past few years and the slowdown of growth in China go a long way to explaining the recent recessions in Brazil.

Commodities include many raw foods and materials used in manufacturing, including wheat, cocoa, coffee, iron ore and copper, as well as the more well known examples of oil and gold. Rather than being bought and sold directly by investors–what are known as ‘spot’ deals–they are commonly traded as futures contracts, standardized agreements between a buyer and a seller to exchange an amount and grade of an item at a specific price and future date.

These can change in value as the price of the underlying commodity rises or falls. But these markets can be volatile because they are susceptible to many unpredictable factors–bad weather can destroy crops and industrial action can shut down a mine.

Since the summer of 2014, there has been a sustained drop in commodity prices, most evidently in energy markets. Some of the decline can be attributed to supply issues. Notably, the newfound abundance of US shale oil and gas, and the resulting fight for market share by the Organization of the Petroleum Exporting Countries have led to plentiful supply and falling prices.

When commodity prices fall, EM shares can become good value.