Commodities rally benefits Chile, Indonesia and Russia

Amid a continuing bounce in most commodity prices we highlight: i) the pole position of Russia among the larger EM equity market plays; ii) the greater prevalence of commodity exporters in small EM-FM equity markets compared to Tech exporters in large EM; and iii) the relatively attractive valuation of Chile and Indonesia in that small EM-FM bracket.

The bull case for commodities

A bullish case on commodities (and commodity-related equities) might be grounded in the following four factors:

1. Policy-led (both monetary and fiscal) increase in overall demand, particularly for infrastructure (in both the US and China), and a Covid-19 vaccine enabling a return to more normal economic activity.

2. Recent constrained capacity addition resulting from poor access to capital (in turn, due to the reallocation of capital globally to Technology sectors, weak commodity prices in recent years, Covid-19 disruption, ESG investor concerns).

3. Weakening US$ and accelerating US inflation outlook (driven by particularly aggressive policy stimulus in the US and less extreme flight to safety as Covid-19 lockdown disruption subsides).

4. Technology falling out of favour should investors worry more about high valuation multiples, antitrust regulation in the US, fintech regulation in China, nationalist regulation in the US and China ("splinternet" for applications and duplicated supply chains for hardware), China-Taiwan-US conflict, and slowing growth in more of the largest companies (eg Apple).

Commodity export exposure in EM

For those more bullish commodities, we depict below the economic exposure of large and small emerging markets to commodity exports, using UNCTAD data from 2017.

In broad terms, Sub-Sahara and North Africa, LatAm, Former CIS-Russia, and GCC benefit relative to Asia. More specifically:

• Larger EM: Brazil, Saudi, South Africa, and Russia benefit relative to China-HK, India, Korea, and Taiwan in larger EM.

• Asia small EM-FM: Indonesia, Malaysia, Thailand, and Vietnam benefit relative to Bangladesh, Pakistan, Philippines, and Sri Lanka.

• LatAm small EM-FM: Chile, Colombia, and Peru benefit relative to Argentina and Mexico.

• Wider Europe small EM-FM: Iceland, Kazakhstan, and Ukraine benefit relative to Turkey and Romania.

• GCC-Levant: GCC, Iran, and Iraq benefit relative to Jordan and Lebanon.

Obviously, commodity bulls will want to distinguish between commodities; eg traditional infrastructure (iron ore, steel), new power generation and transport technology (copper, cobalt, lithium), traditional transport (oil), food (soybean, corn), and stores of value (gold, silver).

Larger EM: Russia top commodity pick

In larger EM (countries with over a 2.5% weight in MSCI EM), there is a split between commodity exporters (where commodity exports are over 5% of GDP) – Brazil, Russia, Saudi Arabia, South Africa – and commodity importers (where commodity exports are below 5% of GDP) – China-HK, India, South Korea, Taiwan.

Russia, Saudi, and South Africa are cheaper than Brazil on trailing PB and PE versus history. And within this subset, Russia clearly has the most credible fiscal policy (with the lowest fiscal deficit and external debt levels). Therefore, in larger EM, Russia should offer the most compelling equity play for those wishing to play the rotation from Tech-heavy ytd outperformers (China-HK, Korea, Taiwan) to commodity-export ytd underperformers.

Small EM-FM: Chile, Indonesia among cheapest