Emerging market assets have always experienced good performance during times when commodity prices are rising. These periods are characterized by strong economic performance of the global economy relative to the that of the United states and they are normally accompanied by a weak U.S. dollar. This combination of relatively strong growth and a weak dollar and the stimulative effect of higher commodity prices on commodity-dependent economies typically underpins bullish stock markets in EM.
The persistent relationship between commodities and emerging market stocks is illustrated in the chart below which tracks the prices of copper (black), EM (red) and the copper mining giant Freeport-McMoRan (blue). (Copper is used as a surrogate for economically sensitive commodities). The chart shows that the prices of these three assets are directionally linked. Arguably, copper is a leveraged play on emerging markets and copper mining stocks provide further leverage on copper itself. This illustrates clearly the cyclical nature and economic sensitivity of emerging markets. It also raises an interesting and perhaps disturbing question for emerging market portfolio managers: why not obtain your general exposure to EM by simply timing the cycle and piling into a few mining stocks?
The viability of this strategy is shown in the next two charts. The first chart shows the performance of emerging market stocks (VEIEX) and of several of the most prominent mining stocks (Vale, Freeport-McMoRan, Vale, SQM and Southern Copper). These mining stocks all dramatically outperformed during the four cycles under consideration (2000-2008, 2009-2012, 2016-2018, and 2020-). Using a very simple 200 day moving average to trigger buys and sells, an investor could have enjoyed most of the upside and very little downside. The investor could have either shifted into cash or stayed invested by owning the EM index whenever the copper price moved below the 200-day moving average. The entry point this year would have been the first week of June. As the second chart shows, since that time the mining stocks have ramped up and left the EM index behind. This outperformance has occurred even though tech stocks in Asia have become much more important in recent years. Moreover, the performance is even much better compared to the EM ex-China index or a commodity-heavy index like Latin America.
Historically, reflation trades trend for long periods. If this one gets traction during the next six months, this trade may be only beginning.